How To Buy Commercial Real Estate in 5 Steps

The world is teeming with investment opportunities. Maybe you’ve looked into day trading or stock options, but you’ve been told real estate provides one of the highest ROIs in the long run. 

If purchasing multiple single-family homes and renting them out to tenants doesn’t sound like the type of investing you’re looking for, commercial real estate might be a better option for you. 

Knowing how to buy commercial real estate – including financing options and what properties are worth investing in – can give you the confidence you need to move forward. 

Table of Contents:

What is Commercial Property?

Commercial property refers to real estate intended for generating income. Buildings with living spaces are classified as residential or commercial based on the number of units each has. If a building has four or fewer residential living spaces, it’s considered a residential building. If a building has five or more residential units, it’s considered commercial property. 

Commercial real estate (CRE) property includes office buildings, medical centers, retail stores, hotels, and warehouses.

Types of Commercial Real Estate

There are five main types of commercial real estate. Each is divided based on the purpose of the space and will likely provide different levels of ROI based on location, function, and size.

Commercial Real Estate Property Type
  • Industrial – Manufacturing buildings and distribution warehouses are two examples. These properties often house heavy equipment and docking areas for trucks to load and unload goods.
  • Office Space – Buildings that house multiple business offices. You can find many of these buildings in the financial districts of most major cities.
  • Retail – Includes shopping malls, mom-and-pop shops, and other buildings that house retail stores like Patagonia or Walmart.
  • Multi-family Housing – Real estate that contains five or more residential living spaces.
  • Hospitality – Hotels and restaurants are both examples of hospitality real estate.

 

In some instances, a sixth category for special properties can be used if the property doesn’t clearly fit into the five previously mentioned. 

The types of commercial real estate can be further broken down into the quality of the asset. This system is often referred to as grading and has three different classes – Class A, Class B, and Class C. 

Commercial Real Estate Gradings
  • Class A – Typically of the highest quality, boasting high-end finishes, modern design, state-of-the-art technology and a variety of sought-after amenities. Class A buildings are also in prime locations.
  • Class B – Many of these properties are in decent condition but relatively old and in need of a few updates. You may find historic buildings fall into the Class B category because of their naturally outdated features.
  • Class C – If a building fits into this tier, it likely needs many updates and isn’t in a prime location. These properties often have cheap rent and supply basic functionality.

 

So, why invest in commercial property in the first place? Keep reading to learn about some of the benefits of investing in commercial vs. residential property. 

Why Invest in Commercial Property?

Tax reductions, portfolio diversification, and return on investment are some of the biggest benefits of knowing how to buy commercial real estate. However, they aren’t the only ones.

  • Tax Benefits: While taxes on capital gains from the stock market are difficult to reduce, it’s possible to significantly lessen the amount of taxes you pay on capital gains from CRE. One way to do this is by including the cost of the building’s depreciation on your annual tax reports.
  • Upkeep and Maintenance: If your commercial property houses business owners who regularly have customers coming in and out, they’ll be more likely to keep the space well kept and professional.
  • Stronger ROI and Cash Flow: The average return on investment for single-family homes amounts to only 1.32%, while low-rise apartments average a 9% ROI and industrial buildings average a 9.5% return.
  • Portfolio Diversification: Diversifying your investment portfolio is the best way to build a safety net when the stock market goes bearish or other investments underperform. There’s also a number of ways to diversify within commercial real estate itself, providing additional support.
  • Syndication Opportunities: If investing in a property on your own sounds daunting, real estate syndications involve one head person and multiple other investors who let the head person handle most of the transaction details. This enables you to benefit from CRE and passively invest, without having to do any legal reviews, inspections, or negotiations.
  • Less Competition: Because investing in commercial real estate can be seemingly more difficult than investing in residential real estate, there are relatively fewer investors who aim for CRE ownership.
  • Longer Leases: Commercial property lease contracts are often longer than residential lease contracts, supporting a higher cash flow and long-term ROI. Commercial lease agreements often last multiple years at a time.

How to Buy Commercial Property

Knowing how to buy commercial property can make the task feel more attainable. This process includes building your network, identifying available opportunities, quantifying your potential return, securing financing, and finally, closing the deal. 

The intricacies of each step will vary depending on your specific investment strategy, available funds, and experience.

Step 1: Build Your Network

By building your network, you open doors to opportunities that are closed to outside investors. The best way to build your network is to find mentors who are willing to help you reach your goals. 

Learning from those who have gone through the process is just the first step in knowing how to buy commercial real estate. Connecting with private investors, attorneys who understand real estate law, real estate agents, and property managers who can all offer their advice and services is crucial for being a successful commercial real estate investor. 

Here at Revolution Realty Capital, we’re more than just a lender. We’re also a team of private investors with on-the-ground real estate experience to offer expertise throughout your investment journey. 

Additional education methods include:

  • Market reports
  • Podcasts
  • Ebooks 
  • Classes at local community colleges
  • Real estate investing seminars
  • Textbooks 
  • Blogs (like this one)
Investor Tip:
By learning how to underwrite your own commercial real estate deals, you can save money and improve your profit margin.

 

Step 2: Identify the Opportunity

Before buying commercial real estate, ensure your investment will be profitable. You can do this by looking at the purchase price compared to similar building values in the market, current net operating income, and any repositioning opportunities.  

Other considerations: 

  • How the property is zoned
  • Property taxes
  • Repairs needed
  • Current rent prices 
  • Operating expenses
  • Net Operating Income

Step 3: Quantify the Return

Return on investment can be calculated a few different ways. However, the property investment return method is generally preferred by commercial real estate investors as it takes into account rental income. 

Property Investment Return: 

[(Monthly Earnings x Length of Time) / Property Value] x 100%

For example, let’s say a commercial property is worth $800,000 and earns $10,000 each month. 

Property Investment Return: 

[($10,000 x 12 months) / $800,000] x 100% = 15%

Your property investment return would be around 15% in this example. However, keep in mind that ROI isn’t the same as profit. Other expenses, including loan repayment and maintenance costs, will eat into your bottom line. 

Investor Tip:
By learning how to underwrite your own commercial real estate deals, you can save money and improve your profit margin.

 

Step 4: Secure Financing

Numerous financing options exist for commercial real estate investments. Typical requirements for securing such financing often include an adequate down payment, exit strategy (for hard money loans), and equity or sufficient collateral. 

 

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Step 2: Identify the Opportunity

Before buying commercial real estate, ensure your investment will be profitable. You can do this by looking at the purchase price compared to similar building values in the market, current net operating income, and any repositioning opportunities.  

Other considerations: 

  • How the property is zoned
  • Property taxes
  • Repairs needed
  • Current rent prices 
  • Operating expenses
  • Net Operating Income

Step 3: Quantify the Return

Return on investment can be calculated a few different ways. However, the property investment return method is generally preferred by commercial real estate investors as it takes into account rental income. 

Property Investment Return: 

[(Monthly Earnings x Length of Time) / Property Value] x 100%

For example, let’s say a commercial property is worth $800,000 and earns $10,000 each month. 

Property Investment Return: 

[($10,000 x 12 months) / $800,000] x 100% = 15%

Your property investment return would be around 15% in this example. However, keep in mind that ROI isn’t the same as profit. Other expenses, including loan repayment and maintenance costs, will eat into your bottom line. 

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Types of loans available: 

  • Small Business Loans: The U.S. Small Business Administration (SBA) offers several loans ranging from $500 to $5.5 million for small business. Be aware, however, that not all SBA loans can be used for real estate. 
  • Small Balance Commercial Real Estate Loans: Used specifically for purchasing commercial property and ranges from $250,000 to $5 million. 
  • Seller Financing: This type of financing is secured by a lien on the property by the previous owner. The seller typically gives the buyer a secured loan to finance a portion of the purchase price. 
  • Conventional Loan: Traditional real estate loans are typically issued by banks and credit unions. The down payment for conventional loans ranges from 20% – 35% and there isn’t usually a maximum loan amount.
  • Hard Money Loan: These loans are offered by private lenders and are short-term in nature. As such, interest rates are higher than traditional loans but closing periods are much quicker and only interest is paid during the life of the loan.

Step 5: Close the Deal

Closing on a commercial real estate property follows a similar process as closing on a single-family home. 

Once your offer has been approved, you’ll go through a due diligence period. During this time, you’ll be able to conduct any necessary inspections. You’ll likely have to pay for these inspections out of pocket, but it’s important that you don’t skip over them. 

Special use inspections by engineers or surveyors can ensure that this property will fit your needs and business goals, while general inspections can give you peace of mind knowing your building meets code and everything is in working order. 

After the due diligence period, there will likely be a period before closing where financing contingencies are worked out. The exact time frame for this can vary depending on your lender.

Commercial Real Estate FAQ

Even after everything you just learned, you might want to learn more about how to buy commercial real estate. If you’re still wondering if you can buy a commercial property to live in or what questions you should ask when buying a commercial property, you’ll find your answers – and more – below. 

Who Buys Commercial Property?

Individual investors and companies often purchase commercial real estate. Large corporations like Walmart purchase their own buildings as well as the associated land so they have full ownership and control over the property. Individual investors or groups of investors often purchase properties in order to grow or diversify their investment portfolios. Although the end goal is different, both entities are often found buying a building for business purposes. 

Can I Buy Commercial Property to Live In?

As long as the property is zoned for residential use, you can live in the building. If a building is not zoned for residential use (such as warehouses and retail centers) it is illegal to reside in the building.  

What Questions Should You Ask When Buying Commercial Property?

You should always ask questions about the building’s history, structure, and ways it may impact your tenants or their customers. Specific questions include: 

  • Does the zoning allow for your desired use? 
  • Are there any expired permits or other issues that may lead to legal liability for you?
  • Is there any structural damage or issues that could make the building unsafe? 
  • Are there any current tenants? 
  • Is the building ADA compliant? 
  • Are there any environmental concerns with the property? 

Does MLS Have Commercial Listings?

Many MLS databases provide information on commercial property for sale. Sites like CoStar and 42Floors are just two platforms that provide commercial real estate listings.

Although intimidating at first, it doesn’t take a finance degree to learn how to buy commercial real estate. However, it does take someone willing to ask for advice and support from seasoned professionals. If you’re ready to take the leap, reach out today

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Key Takeaways

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Daniel William

Co-Foundet Acme Corp

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