What You Need To Know When It Comes To Commercial Real Estate
At its core, Commercial Real Estate sales are somewhat similar to residential real estate. But there are some major differences, too: different rules and regulations, different sales strategies, different price and value indicators and different metrics to consider when buying or selling.
Before going any further, we need to point out that when we say Commercial Real Estate, we're really talking about small stand-alone buildings with business or mixed-uses. We're not talking about shopping centers, hotels, office complexes or strip malls. That's a different real estate specialty altogether. Our Commercial expertise lies in the types of buildings that you typically find along Benicia's First Street or in other local downtowns. If you're looking for information on larger types of properties, let us know and we can refer you to someone who specializes in that realm.
Buying A Commercial Property...
Buying a piece of commercial property is quite different than buying a home or residential rental property. For one, there are fewer disclosure requirements for a seller of a commercial property, so it's important for buyers to perform thorough inspections. Unlike a home that the seller is living in, most commercial property owners are rarely at the property and probably aren't aware of some of the property's flaws and problems. That said, sellers must disclose matters they're aware of. So if they know the roof leaks or the heating system is faulty, they still must let the buyer know.
Cash Sale or Financed?
Will you be paying all cash or financing the purchase. If you plan to use financing you should know that many residential mortgage lenders don't handle commercial financing. Commercial banks are usually a good source.
You should also know that interest rates on a commercial loan are usually higher than on a residential mortgage. Plus, the length of the loan is usually shorter and the minimum down payment is usually higher on a commercial loan as well. Commercial appraisals take longer and are more expensive and the processing time is longer, too.
In residential real estate, appraisers rely primarily on comparable sales of similar properties. And while commercial appraisers rely on the comps, too, they usually put more emphasis on the property's income potential and perform calculations comparing the price and expenses to the property's rent potential. So just because a similar property sold for the same price as what you're planning to sell yours for, unless they're identical properties with identical rents, don't automatically assume that an appraiser will assign the same value to both properties.
Getting thorough inspections are extremely important. They're considerably more expensive than home inspections and they take longer, too. It's important to use inspectors who specialize in commercial inspections. It's important to know whether the building complies with ADA requirements, fire codes, sanitation requirements, etc. and only a dedicated commercial inspector will know those things.
And as noted in the seller's section above, whether or not you're financing the purchase, be sure to obtain a Phase 1 environmental report to make sure there weren't any potentially worrisome uses on the property in the past. Many of these reports identify uses going back more than 100 years.
Review The Sellers' Paperwork Carefully
It's easy to get caught up in the excitement of owning a piece of commercial property, but don't let that enthusiasm distract you from carefully examining the lease, estoppel certificates and seller's financials. They're the biggest window into whether this property makes sense financially.
Many sellers keep loose records or have tenants who are either overpaying and don't know it or who took occupancy very recently. Buying a property with several vacant units and assuming they'll easily rent for what the current tenants are paying is a dangerous approach.
If the tenant is very new, find out how long the previous tenants were there and why they vacated. Make sure who's responsible for what is clearly spelled out in the lease. And that both parties honor what's in the lease. Look for red flags or inconsistencies on the seller's income & expense records.
If the lease says he's getting $9,500 a month but he only showed $85,000 in income over the past 12 months, something may be afoot. Or, if it calls for the tenants to pay utilities but the seller shows $25,000 in utility expenses, a question must be asked.
Selling A Commercial Property...
Selling a commercial property requires a lot of upfront legwork before putting the property on the market. And a big part of that is collecting and organizing paperwork that buyers will want to see, including:
- Copies of existing leases & other written agreements between the owner and each tenant
- A statement indicating who's responsible for utilities, maintenance & insurance
- Copies of bills for utilities that are the owner's responsibilities
- A statement identifying whether the owner or tenant owns the various pieces of equipment and appliances
- Income & Expense statements for the past 12 months
- Rental histories for each tenant
- Copies of permits
- Details on any structural modifications
- Disclosure of past or present violations, litigation, disputes or complaints
You'll also want to obtain an Estoppel certificate from each tenant. These are signed affidavits where the tenant confirms the monthly rent, length of their lease, security deposit, etc. No buyer wants to inherit a disgruntled tenant. The estoppel certificate tells the buyer whether the seller and tenants are on the same page.
Several other important things Commercial Sellers should know about:
- Most buyers will obtain a Phase 1 Environmental report. If they're financing the property, this is a must. They're not required on a cash purchase, but a prudent buyer would certainly get one. These reports go back many decades and identify any past uses on the property or nearby that might indicate a potential environmental concern. If the report identifies a potential red flag (ie. a gas station, dry cleaner, auto repair shop) it will usually recommend a Phase 2 inspection, which usually requires taking core soil samples and sending them to a lab.
- If some of the rental units in your building are vacant, be sure you price the property based on realistic market rents. The buyers and/or their appraiser will certainly do their own analysis of the property's income potential, so your asking price must be supported by a realistic rent roll.
- Make sure the property's current or projected uses are consistent with the city's general plan and zoning ordinance and that any necessary repairs or improvements you'll need to make prior to close of escrow are allowable. If you're in a historic district, for example, clearing items on a pest report could mean having to use expensive, hard-to-obtain architectural materials.
Find Out More...
This is just a short overview of some of the important considerations for buyers and sellers of commercial property. If you'd like to explore this type of real estate further, please contact us and we'll be happy to schedule a complimentary no-obligation meeting with you.
Knowing what to expect and deciding whether commercial real estate is right for you should happen at the outset, not when you're in the midst of a costly time-consuming escrow.