10 Tips to Successful CRE Ownership
1. Location, Location, Location
Location is everything, it is in fact the top hurdle to conquer for any business. Commercial properties provide returns through two avenues; Rent and Capital Appreciation. Both are heavily dependent on the location. Look for locations where vacancy is less than 7%. This will mean that supply is in check and tenants are less likely to vacate, leading to higher rents and capital appreciation. A high vacancy location gives tenants options to move and renegotiate rents. And do not forget to look for a property that’s convenient for customers and easily commutable for employees, but also not too far from suppliers. 2. Zoning Know what kind of zoning your business needs and make sure your prospective location will allow you to do what you need to do on-site. An accounting firm needs commercial office space, while a manufacturer should look for an industrial space instead. Familiarize yourself with local zoning laws and see how they limit what can take place on the property.
3. Demand vs Supply This is one of the first things a savvy investor has to analyze before committing to buying a commercial property. Every city has different micro-markets. Each micro-market has a stock (amount of office already completed and leased) and upcoming supply. Consider this, If the annual supply over the next 2-3 years exceeds historical demand, the rents and prices would come down. A disproportionately high supply will affect both new and old buildings. New buildings will command lower rents as tenants will get more options in the market while tenants in older buildings will renegotiate rents and escalation clauses. 4. Quality of tenant A good tenant can significantly increase the value of a commercial property. Looks for blue-chip multinational tenants and avoid smaller and unknown companies. Good tenants pay rents on time, pay higher deposits, stay longer and increase the value of the property. 5. Quality of Property Two buildings may be in the same location, but the one boasting better quality will always get rented first. It will also attract better quality of tenants. Needless to say, it will fetch the investor higher rents, better tenant retention and higher capital appreciation. Multinational tenants are always willing to pay a premium for quality. Look at general wear and tear of the building and any environmental issues that could crop up in the land itself. Look for buildings that have nicer looking lobbies, more elevators, higher ceiling heights and better views. Higher quality properties are also more liquid and can be sold much faster.
6. Income and Expense Commercial properties are valued on their Net Operating Income, which is defined as their income less expenses. To start with, obtain the general details of the leases, you will want to review the landlord or property manager’s tenant rent roll. A good rent roll should summarize key tenant lease terms: tenant names and contact information, rent payable, periodic rental rate increases, lease structure (e.g., triple net or gross), and term or duration of the lease, among other things. It’s good practice to verify the provided rent roll against the actual leases, especially when dealing with less sophisticated owners or operators. To accurately model income, it is important to understand how it is divided between base rental income and operating expense reimbursements. The same goes for expenses, it is critical to understand exactly which expenses the owner is responsible for paying versus what the tenant is responsible for paying. Knowing these details go a long way in modeling investment returns accurately. Remember, The higher the Net Operating Income, the higher the value of the property.
7. Parking space
Inadequate parking space will drive customers away, so make sure you have plenty of space for both visitors and employees to park.
How could adjacent properties affect the value of yours? Nearby road and infrastructure construction could help traffic to your site in the long term but hurt it in the short term. A business that depends on customers visiting, like a restaurant or retail development, would want to avoid moving in near a factory that emits bothersome odors even if the right zoning is available and the space is affordable. However, good neighbors with loyal customers can help drive business to your door as well by attracting people who may also be interested in what you’re offering.
9. Future expansion
Can the property still accommodate you if your business grows? How much growth can it handle before you’ll have to move? Conversely, if your business doesn’t grow, is the property structured in a way that allows you to rent out your surplus space?
10. Diversification We’ve all heard that diversification reduces risk. This is especially true in commercial real estate. If you invest all your savings in one property, you are exposing yourself to a higher risk. In case the tenant vacates, rents will stop while maintenance payments, property taxes etc. will have to be paid. Investing in multiple properties across cities will reduce variance in income by diversifying property level risk.