Buying commercial real estate is a big decision that will have a huge impact on company’s cash flow, balance sheet, and lending options. Because of this it’s important that business owners or executives take their time and carefully evaluate when it would make sense to stop renting and buy commercial real estate.
Believe it or not only a small portion of businesses with great financials have the cash available from operations to invest in commercial real estate. In other words, most companies are going to require third party financing to buy commercial real estate and those lenders will want to see that the following 5 conditions are met:
1) Know Your Long Term Commercial Space Needs – Before you purchase a commercial real estate property whether office, retail, or warehouse space, it’s important that you know your space needs over the next 3,5, or 10 years. Investing in commercial space takes a lot of time and money so the last thing you want is to outgrow your space within a year or two. So if your business is still in growth mode (e.g. staff, customers, and/or products & services) and you cannot forecast your space needs over 3-5 years then you should wait until you have a better handle on that before you buy.
2) Show Your Historical Profits & Cash Flows – Buying commercial real estate is a long term asset. Companies with a long term track record of being profitable are in a better position to do so as they have excess cash at the end of the year after paying taxes, etc. Companies that have only been profitable for 1-2 years should focus more on reinvesting extra cash into business operations to ensure they have enough key sales/marketing staff, inventory, etc to support growth. After 3-5 years of being profitable then companies can consider investing in long term assets such as commercial real estate.
3) Have Plenty of Cash Reserves – When buying commercial real estate you NEED CASH. Most lenders will require that you put down at least 10% to 30% to finance a property. So if the property you like is $1,000,000 you will need to put down somewhere between $100,000 and $300,000.
4) Compare Cost to Lease Vs Purchase – It’s not always advantageous for you to buy a commercial property. To make sure that you are making the best decision possible you need to do a lease vs purchase analysis. The minimum comparison should be between the monthly rent and estimated mortgage payment, including interest, principal, and taxes. Ideally your real estate expenses should be 10% to 15% or less of your total revenues. So if your lease option represents 10% of your total sales and a purchase option represents 18% of your total sales then you might want to hold off on buying until either the market settles down or you find another opportunity.
5) Find the Best Location Possible – It’s important that you evaluate each location and choose the ones in stable and/or emerging geographic areas. Some examples of trending areas are those a lot of development activity, public infrastructure improvements, and areas growing demographics and incomes.
There is a time to buy commercial real estate and a time to lease it, however before you decide to buy make sure you consult with your business plan, CPA, and commercial real estate consultant. Carefully evaluate all your options and financial outcomes and you will put your company in a better position to succeed.