3 Reasons Why Commercial Real Estate Investing Might Be Your Next Step

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Wondering how I got started in commercial real estate investing?

Almost 10 years ago now, I was at a crossroads with my investing career. At that point, after investing in residential real estate units for approximately 15 years, I started to ponder the idea of going into the commercial real estate investing arena. It just seemed like the next logical step, I had always done single-family units for the most part but I did buy a six unit building once and had three duplexes and some commercial garages that I had built. I had been a realtor, rehabber and painting contractor throughout these first 15 years and now I was thinking bigger. After all, in my opinion it’s just more zeros, right?

How I Got Started with Commercial Real Estate Investing

When I was thinking about getting into commercial real estate investing, I started to try to find some places that were available in the Philadelphia area and I was struggling.  There just wasn’t much available at the time where the numbers seemed to work.  Everything just seemed too expensive. Personally, I preferred something over 100 units because in my mind it could justify an on-site manager and an on-site maintenance man. Then by chance, something happened.

At the time of my conundrum, I ran a Real Estate Investor networking group and a company from New Jersey came to speak about commercial real estate. I was floored by their presentation, it just made sense. With experience raising private money, I was able to join their team assisting this company with the fundraising of private capital. What I learned next was that by using private placements these owners were purchasing $30 million worth of commercial property and a storage center with none of their own money.

We went on to raise $8 million for down payments and improvements and they proceeded to get some form of owner financing. Private placements also insulated the owners from most of the liability if anything went wrong. Their goals at the time was to turn the parks around within five years, raise lot rents, refinance and pay back their private investors. Now the $30 million worth of commercial property would be all theirs. Here’s the best part, they had no previous experience other than taking a Scott Scheel course! What they learned and taught me was really why it makes sense to invest in commercial property.

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Three Reasons Why Commercial Real Estate Just Makes Sense

Economy of Scale

To put it simply, you can manage a lot more apartments, mobile home parks, and offices than you can manage residential homes. Did I say a lot? Because I mean A LOT more, like 100’s of units more. If you have enough units to justify an onsite manager and maintenance person, you can give them a free apartment and/or a small salary and you’re out of the property management game. Plus if they live there, this person will most likely be on call 24 hours a day – this gives your place a better reputation, makes people happy, and it keeps the property up to date and in good shape.

Plus you don’t really have to hire too many outside contractors; some maintenance departments even paint and cut grass. And the contractors that do come in will usually give a discount since with large apartment complexes they’re getting quantity work, that’s usually steady as well. I know because I used to be a contractor for places like these and they were my most consistent jobs every month. Also owning a large commercial property usually simplifies the maintenance and upkeep of the units by having all the same carpet, paint, furnishings, etc.,

Valuation

Market comps and replacement value do play a part in valuing commercial property, but the TRUE value is found by determining the NOI (Net Operating Income). Net Operating Income is Gross Income minus operating expenses (and it doesn’t include debt services).  There’s a great example in one of Scheel’s articles called How Commercial Property is Valued that simplifies the process greatly, “Let’s say a commercial property generates $100,000 in NOI.  Investors in most parts of the country would gladly pay $1 Million to buy a property with a $100,000 annual income stream (a 10% return).  This desired return on investment is also known as a ‘cap rate’.

Thus, as a (very general) rule of thumb, you can take the NOI of a property and divide by 10% (or an appropriate CAP rate for the market you are evaluating) to determine the value of the property.  If you were able to find a way to increase the NOI on that same property from $100,000 to $150,000 [(by say raising the rent, lowering vacancies, etc.)], the property would rise in value from $1 Million to $1.5 Million (based on a 10% cap rate).” And this of course is a major concept with commercial real estate investing. Much like residential, you don’t make the most money with a property that’s in great shape, you make the most money with a property that needs work or that could have it’s value raised.

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Creative Financing

Probably my favorite of the three reasons is that you can purchase multi-unit properties with little or no money down through private money partners.  Commercial loans are often more lenient and flexible than residential loans. You can also use a combination of financing.  For example, if you were buying a $10 million commercial building, the bank may lend you $7.5-8 million and the balance may be raised with a combination of owner financing and private money.  The seller may hold a 2nd mortgage of a million dollars, interest only for 5 or 7 years.   The remaining million dollars along with closing costs and renovation capital could be raised through a private placement.

In this example, the managing partners would be Class A members with at least 51% ownership (to maintain control) and would oversee day-to-day operations and could not be voted out under normal conditions.  The remaining investors would be Class B members and would own shares of whatever the company owned whether they’re units, equipment, rental bank accounts, etc.  Keep in mind the buyers will be receiving all security deposits and often times are allotted repair credits from pre-purchase property inspections or seller assists towards closing costs when negotiating the purchase of the property.

I have seen cases where buyers walk away from closing with cash. For example, I had a guy from my local commercial group who walked away with cash in his pocket at a recent closing from doing what is called a lease-back. A lease-back is an arrangement where the seller of an asset leases back a portion of the same asset from the purchaser. This enables the seller to lease back some vacant space in the current building, paying for it in advance at closing, and allowing the buyer to get better financing from the bank by raising the value of the property through the increased NOI.

So Now What?

Today, I’m still involved in several commercial deals. I still utilize many of the skills I’ve learned, especially those involving fund-raising through private placements, with a variety of new projects today. I’m currently working on a 12,000 square ft. office building deal (and it looks like the sellers are willing to hold some paper too!). So when are you going to jump in the commercial pool and take action? Go out and join a commercial real estate group, ask questions, read books, and get started today!

Would you consider commercial real estate investing? Why or why not?

Be sure to leave a comment below, and let’s talk!

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

31 Comments

  1. Well I got into Commercial, Student Housing, Office building in 2008, and now have big problem. May lose Office building, and Student Housing is hardly giving 2% COC. So no luck for me in this TIC’S. investment. Would prefer single tenant on my own net lease property. Thanks

      • I was an investor, and yes they had PPM for accrediated investor. Office building in Dayton , ohio near Wright Air Force base. With no government contract, occupancy is only 75%, not enough to pay mortgage and expenses. Bought fot 36 million, loan for 26, and value now 15 million, so big problem. Attorneys trying to negotiate with lenders.
        Student housing has new apts in area, so tough time also.

        • Kris,

          In the past I’ve been in a similar position, where I was a Class B investor and lost money. I can empathize in with your situation, the most important lesson I learned from the experience though was when I gave up control of my investment dollars I was running my biggest risk.

          In my article this is why I suggest becoming a Class A member with control and limited liability with the goal to become the sole owner (or one of the sole owners) down the road. And commercial isn’t the only option of course, in fact I have multiple passive streams with limited liability myself, like private money, notes, and tax liens.

          Regards,
          Dave

  2. Brandon Turner

    Dave, this was an awesome article! I really want to get into more commercial and less residential, for all the reasons you stated. I’m a big fan of apartments, so I hope to do more and more with it. The biggest problem I have is raising larger amounts of capital. I live in a lower income area so i don’t connect a lot with wealthier people. Maybe a decent future blog topic!? 🙂

    • Thanks Brandon! I like the suggestion, the biggest thing it comes down to is networking and building a money list equally as hard you build your buyer’s list. I’ll elaborate on it more in one of my next articles!

      Best,
      Dave

  3. One of the best articles I have ever read on BP. I have heard of Scheels and his courses. I also know of Dave Lindahl who teaches and specifically does commercial deals only.

    Lindahl talks a lot about creative finance and how he has gotten into properties (he says he owns over 7,000 units) with little or none of his own money by using syndications, owner finance, equity and debt partners, etc… He is also really big on repositioning deals and increasing the NOI dramatically like you mentioned to increase value.

    Thanks for writing this and showing that some “guru” courses are not all bad and that multi-million dollar deals can be done without your own money.

    Are you saying you recommend Scheels and his stuff then?

    • Nick,

      Appreciate the feedback, makes me feel like I’m doing something right!

      And I couldn’t agree with what you’re saying more. I have taken a Dave Lindahl class and I thought he was great too. I’ve seen Scheel speak but I never personally took one of his courses. However, the people I was raising money for spoke very highly of his program. Now they implemented the strategies he taught (which I find many people fail to do when they buy education oddly enough) and they were able to raise almost $10 million for this one deal.

      Best of luck,
      Dave

  4. Dave, you got my blood pumping. Like Brandon, I too live in a middle class location but buy SFR in nice locations for over 45 years. I found out with owning single family homes one can’t really retire. It would be nice to sell a bunch of my properties and buy a large commercial property and let others do ALL the work.

    Very good post, write more on this subject on buying a commercial property from start to finish and “how to” raise money.

    • Jim,

      Thanks for the response! And that’s usually true, or at least I found that to be the case since you’re working more for your money rather than your money working for you.

      I’ll keep the articles coming!

      Best,
      Dave

  5. With 10 years of residential real estate experience, I’ve recently considered expanding into the commercial aspect of our industry. Now that the economy is becoming strong again, I think that commercial work will be plentiful over the next few years. Thanks for sharing your insight!

    • Lisa,

      I agree with you 100%. That’s why when I started, I didn’t venture into commercial alone. I raised money for a company that invested in commercial and I learned from them. That way, I got paid to learn! Join a commercial Real Estate group in your area and start asking questions, you’ll get there.

      Best of luck,
      Dave

  6. Personally, I’ve had success in investing in Main Street commercial properties in small to medium sized towns in the Midwest just make sure you know the local jobs outlook. The best locations would be a small suburb of a large city with a stable job base. Just like on the coasts, trends are changing in the Midwest for people looking for walkability and downtown shops. Many readers may find that the best deals for them may be right in their backyard. Although I do like the larger deals (and if smart then larger payouts) with private placement too, however I understand if someone would want to start on a smaller scale. You also may find that you are the only commercial buyer in a smaller town and then you dictate the price. Just my two cents. Great article. I hope to see more. I think it would be good to go over the different costs associated with commercial real estate and typical terms of a deal which include realtors fees of around $3 per sq ft to move someone in, landlord incentives such as months of free rent, remodeling costs, etc. it would be interesting to me as to what these costs are throughout the country. The caution I would give anyone in the commercial world is that expenses can be large and come all at once. If a tenant moves out, it may take another year to fill the space plus the large costs associated with moving a new tenant in. Once you have a long term tenant in place though life is good.

  7. Andresa Guidelli on

    Hi Dave,
    As you stated it also seems to me that investing in Commercial real estate is a natural evolution. With less than two years of residential experience (rehabbing) would you recommend a transition to commercial?
    Do you still belong to any real estate investors group in Philly?
    I’m looking forward to hear from you.
    Thank you.
    Andresa

    • Andresa,

      Absolutely I would recommend it! My only regret is that I waited so long to do it, I don’t think you could ever start too early. Both fields of Real Estate are similar, but they’re different enough so it almost doesn’t matter what your background is. But I would recommend getting educated and networking before jumping right in.

      And yes, I belong to DIG (Diversified Investors Group) and it’s various sub-groups (including it’s commercial sub-group) and DPI (Delco Property Investors). I also belong to a couple entrepreneur/CEO groups which I find to be helpful as well.

      Best,
      Dave

      • Andresa Guidelli on

        Thanks for the feedback Dave.
        Even though I have real estate education, I agree that commercial its another ball game.
        I belong to a few groups but I will definitely join Dig Com sub group.
        Thanks a lot for the support.
        Andresa

  8. Thanks Dave for the article,

    Its a definite recite worthy piece to entrepreneurs, investors and prospective business partners, that want to be a part of a commercial real estate business.

    envisioning myself closing a bunch of commercial deals or participating in multiple transactions. Recently, networking and education have been my go to moves. Furthermore, the creation of a innovative commercial platform has been on my mind. Am located in the greater NYC area. Commercial bird dogging is the path am taking right now to learn the game.

    Might anyone have a awesome ncnd and fee agreement that I can use? Commercial buyers are all around me in this big apple, so any possible deals that might be a success across states or abroad let me know, either to develop my deal analysis skills , share my buyers, or build a profitable relationship.

    Everyone connect with me, and have a good one,
    Carlos

  9. Hi Dave,
    Great article… I was wondering is it harder to find larger commercial properties with the same cap rate compared to smaller multi-family homes in roughly the same type of area?

    • Taylor,

      Great question! Yes it can be harder to find larger commercial properties with the same cap rate but it might depend on your location and what you’re buying. If you’re talking about buying an apartment complex; commercial guidelines are stricter, it’s generally more capital intensive to buy an apartment building, and the overall expenses are more for an apartment building than it would for a smaller multi-family home.

      Now there is more creative and flexible financing with commercial and there’s an economy of scale (especially when you get into larger commercial buildings), so it’s all a matter of what you’re looking and why.

      Hope this helps,
      Dave

  10. Now it’s a good time to buy commercial properties to see the cap rate go up over next 10 years. It’s a great business in all of its aspects. You will not only provide stable income for yourself, but also create new jobs and provide people with better rental rates in such a low inventory market. Great article, makes you really exciting to dive in to the world of commercial real estate business.

  11. Jarred Sleeth

    Dave,

    I’ve been lurking here for the better part of two years. This post finally gave me the push to go ahead and sign up. I am not far from you in the Baltimore market (though my significant other is from the KOP area and I frequent there), and primarily invest in SFHs for renting. I am dedicating my 2015 calendar year to educating myself in the commercial world and hope to make the transition after that. Commercial was always the end goal for me, but starting with SFH has gotten my feet wet, made me some money, and helped focus on the prize.

    Seeing that our markets are not far from each other, are you connected in the Baltimore area with any groups? I have been to a few before, though they were extremely pitchy and gave me a slimy vibe. I did not return. I will look into Lindahl and Scheel.

    Thanks for the article.

    Jarred

  12. Stuart Fox

    Great article. I have several SFR rentals, I flip homes and do some new construction. However, I know that commercial is where I am going. I need to get my game on! Thank you for the inspiration to make it happen

  13. Investing in real estate can seem like a huge undertaking, but it’s not only for experts or millionaires. Property values often go up over time, and can make a house more valuable when you decide to sell it. Read on for some more great tips on investing in real estate!

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