Commercial Real Estate Basics
Beginner’s Guide for Small Investors
Presented by: Jason S. Buckingham Attorney at Law Law Offices of Jason S. Buckingham, Inc. www.jsb-law.com
IMPORTANT NOTICE: This information is provided for general educational purposes only. It is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice about your situation.
Basic Definitions Residential Property: Public/Institutional: Commercial: 1-4 units; condos for individual sale; co-op. May be held as investments. schools; government offices; churches; community centers; hospitals; parks and open spaces property used for commerce: held for use in a business or trade, for development or redevelopment, or for rental income.
The definitions highlight and illustrate the differences. Four things to know about Commercial Property Investment ONE: In commercial real estate held for rental income, cash flow is king because it determines:
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market value (CAP) lending limits (DCR) your return (cash on cash)
Unlike 1-4 unit properties, for cash flowing commercial property, your credit is much less important than the property's cash flow in the lending decision. TWO: Commercial real estate has unique front end costs. Typical cash requirements (down payment) start at 25% for stabilized, cash flowing multifamily property, and go up from there based on risk (up to 40% or more for development deals). Typical closing costs will be about 4% of the purchase price:
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Survey Tax / Flood Zone searches Title insurance Escrow, notary, recording fees, transfer tax Site inspections / Prop. condition report Environmental Phase-I report Lender approved appraisal Attorney fees for your lawyer AND your lender's lawyer Loan commitment fees Loan commissions and processing fees
This means that buyers need, at a minimum, roughly 30% cash on hand to close on a CRE investment. Programs that allow purchase with less cash are usually a gamble, not investment.
THREE: CRE opens other markets to investors - no more “in my back yard” limitations CRE is analyzed the same way regardless of location:
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Basic demographic and economic data: job growth, income growth, cost of living, crime, cost of doing business Local amenities: schools, business, leisure & entertainment, open space Local insurance risks: earthquakes, hurricanes, tornadoes, flooding, fire Local climate
For educated investors, having CRE in different markets is good, because one disaster won't wipe out entire portfolio, and because an economic downturn in one locale won’t affect profits from other holdings. FOUR: Understanding and limiting risk is the most important skill for a CRE investor to develop. You understand and limit risk by getting the best information before you buy. Teaming up with experts is how you get the best information:
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Broker - find and analyze properties Lawyer - draft contracts, review due diligence CPA - evaluate tax issues
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