Word of Caution For Those New to Commercial

Commercial Real Estate Investing
10yFollow

Word of Caution For Those New to Commercial

Joshua Leite
Professional · Irvine, CA · Member since 2014 · 45 posts · 14 votes

While there are many great facets to commercial real estate there are also many differences compared to residential (SFR or multifamily). Before you consider getting into the commercial side, I urge you to research and make sure you know what goes into the following:

Leasing – Tenant Improvement allowances (what is the current market offering) are a major difference from residential. A landlord may end up needing to put in $2 per square foot of leased space in improvements to get a space leased. This takes a bit of free cash.
Leasing – Broker Commissions – Commercial leases (office, retail, industrial) many times have multiyear terms (3-5, even 10 years) which commercial brokers typically get paid a percentage of total value on. This adds up when leases are valued at $500k+ in total.
Commercial loan escrows – commercial loan servicers often require escrow accounts for taxes and insurance costs. This can reduce your monthly cash flow if you don’t take this into account going into a project.
Management – commercial leases are more complex than residential. You have a breakdown of maintenance obligations, cost recoveries, annual reconciliations. A good management company can stay on top of these items as well as the day to day operations. Make sure you know the leases inside out so you are not leaving cost recoveries on the table.

1Reply
48 views

Most Popular Reply

Robert T.
Investor · Houston, TX · Member since 2015 · 76 posts · 12 votes
10y

All very good points. T.I. allowance is usually much higher than you mentioned. Also, vacancies tend to be longer than residential Higher risk for single tenant than multi tenant. BUT, when the assets are stabilized, it is a great income stream with few hassles. 

1Reply
See this reply in the discussion

10 Replies

Jump to latestLatest
  • Robert T.
    Investor · Houston, TX · Member since 2015 · 76 posts · 12 votes
    10y

    All very good points. T.I. allowance is usually much higher than you mentioned. Also, vacancies tend to be longer than residential Higher risk for single tenant than multi tenant. BUT, when the assets are stabilized, it is a great income stream with few hassles. 

    1Reply
  • Joshua Leite
    OP
    Professional · Irvine, CA · Member since 2014 · 45 posts · 14 votes
    10y
    Originally posted by @Robert T.:

    All very good points. T.I. allowance is usually much higher than you mentioned. Also, vacancies tend to be longer than residential Higher risk for single tenant than multi tenant. BUT, when the assets are stabilized, it is a great income stream with few hassles. 

     No argument there. My TI amount was just an example. It is very dependent on local market, comparable deals and class within cre (retail, industrial, office).

    0Reply
  • Robbie J.
    Investor · Sugar Land, TX · Member since 2014 · 18 posts · 5 votes
    10y

    All good info.  Another thing that comes to mind is learning to spot which tenants will be problem tenants before purchase, and prepare a game plan throughout the year-whether self-managing or managing the managers.  Specifically property tax protests and CAM reconciliations come to mind. 

    1Reply
  • Joshua Leite
    OP
    Professional · Irvine, CA · Member since 2014 · 45 posts · 14 votes
    10y
    Originally posted by @Robbie J.:

    All good info.  Another thing that comes to mind is learning to spot which tenants will be problem tenants before purchase, and prepare a game plan throughout the year-whether self-managing or managing the managers.  Specifically property tax protests and CAM reconciliations come to mind. 

     Or if they will pack up in the middle of the night and leave while declaring BK

    0Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    10y

    It's all in how you buy it. On the retail side I look through hundreds of properties a week. I only like a handful of them maybe 15% to present to my clients.

    Just like SFR or any other class it is about buying the asset right going in and the location.

    If a tenant might be having trouble we tend to do a negotiating settlement for release of liability for the rest of the lease obligation.

    One of my clients we did this. They owed 120,000 the next 2 years remaining on primary. Let them out for about 40,000. Covered the three months of lost rent and TI credit for the new tenant.

    We could have squeezed  more out of them as they owned other locations. Not knowing how the other locations were performing they could have filed BK and we would have received long drawn out payments or possibly nothing at all.

    What I like about strip centers is the low per sq ft rents if you buy right. Easy to release if location is good.

    STNL if you have a long term primary lease then not as much to worry about. If you are buying an STNL property with just a few years left before the option hits you better get it at a higher cap rate. You also need to plan who the tenants who will replace your space if the existing tenant does not renew and what estimate TI requests will be and market lease rate compared to what you are getting now.   

    Podcast Guest on Show #47
    NNN Invest53 Reviews
    WebsiteView Page
    0Reply
  • Neil G.
    Investor · Socal · Member since 2015 · 222 posts · 34 votes
    10y

    notice 3 of the 4 points are for commercial LEASING. 

    what about commercial wholesaling, flipping, building etc? surely loans are often involved, but not leasing, lease commission, nor (rental) property management for short term investment ie improve & flip and/or build & sell.

    are commercial sales commissions typically any different from residential? ie CA would be 5-6% res, same for com?

    0Reply
  • Mark Creason
    Real Estate Lender and Broker · Dallas, TX · Member since 2013 · 966 posts · 500 votes
    10y
    Originally posted by @Joshua Leite:

    Leasing – Tenant Improvement allowances (what is the current market offering) are a major difference from residential. A landlord may end up needing to put in $2 per square foot of leased space in improvements to get a space leased. This takes a bit of free cash.
    Leasing – Broker Commissions – Commercial leases (office, retail, industrial) many times have multiyear terms (3-5, even 10 years) which commercial brokers typically get paid a percentage of total value on. This adds up when leases are valued at $500k+ in total.
     

    $2 per sf is on the low end.  On new space, I have seen up to $30 per sf.  I have also seen 6% commissions on the lease up.  In DFW, seems like 2% for listing agent and 4% for agent bringing the tenant.  On the positive, I do see financing to cover these type of transactions.  If you leased a 2000 sf space at 24 per year per sf for 5 years, you would have a 6% commission on $240,000.  Leasing commission would be $14,400.

    Mark

    1Reply
  • Joshua Leite
    OP
    Professional · Irvine, CA · Member since 2014 · 45 posts · 14 votes
    10y
    Originally posted by @Neil G.:

    notice 3 of the 4 points are for commercial LEASING. 

    what about commercial wholesaling, flipping, building etc? surely loans are often involved, but not leasing, lease commission, nor (rental) property management for short term investment ie improve & flip and/or build & sell.

    are commercial sales commissions typically any different from residential? ie CA would be 5-6% res, same for com?

     Neil,

    Commercial sales commissions typically (and I would say as a caveat this is market dependent) reduce in % as the deals go up in value (think 1% of sale price on deals $25 mil+).

    Regarding flipping or build & sell - in my opinion a commercial flip or build & sell would typically involve leasing and lease commissions. Commercial property values are driven by their rental income and expected future cashflows - ie if you don't have leases in place the value is reduced. If you are flipping and you take a 50% occupied building to 100% occupancy along with completing deferred maintenance you will more than likely have TI costs and definitely leasing commissions to pay.

    1Reply
  • Joshua Leite
    OP
    Professional · Irvine, CA · Member since 2014 · 45 posts · 14 votes
    10y
    Originally posted by @Mark Creason:
    Originally posted by @Joshua Leite:

    Leasing – Tenant Improvement allowances (what is the current market offering) are a major difference from residential. A landlord may end up needing to put in $2 per square foot of leased space in improvements to get a space leased. This takes a bit of free cash.
    Leasing – Broker Commissions – Commercial leases (office, retail, industrial) many times have multiyear terms (3-5, even 10 years) which commercial brokers typically get paid a percentage of total value on. This adds up when leases are valued at $500k+ in total.
     

    $2 per sf is on the low end.  On new space, I have seen up to $30 per sf.  I have also seen 6% commissions on the lease up.  In DFW, seems like 2% for listing agent and 4% for agent bringing the tenant.  On the positive, I do see financing to cover these type of transactions.  If you leased a 2000 sf space at 24 per year per sf for 5 years, you would have a 6% commission on $240,000.  Leasing commission would be $14,400.

    Mark

     Like I said, that was just an example from a local market for industrial properties above 100k sq. ft.

    0Reply
  • Neil G.
    Investor · Socal · Member since 2015 · 222 posts · 34 votes
    10y

    does commercial include multifamilies over a certain unit #, and if so, what is that magic #?

    4?

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free