Owning your own commercial property for your business can be a rewarding experience and can be a great investment vehicle. However, buying a commercial property can also be fraught with unforeseen pitfalls that can cause you headache and can cost you dearly. This guide should help you avoid some of those pitfalls and will give you direction on the next step to take when considering buying your own commercial building or office condo.
Do You Really Want to Buy a Commercial Property?
To many, the prospect of buying a building seems like the best way to cover the occupancy needs of their business. Most compare building ownership to home ownership where the ownership advantages are obvious. However, building ownership has some distinct differences that make ownership good for some companies and not good for others. Here are some things to think about when considering buying a commercial property.
1. How Stable is Your Business?
Not just financially, but also from an occupancy perspective. Yes it is true that you need a good financial situation business-wise and/or personally, to qualify for a loan to buy a building. However, you’ll also need to consider how the new building will work for your business over the long run. Many businesses have bought buildings, spending a tone of money and time in outfitting the building to suit their business needs, only to find that they quickly outgrow the building and have to end up looking for an alternate solution. For most, business growth is the key to their success, and an obsolete building can be a real headache when it won’t sell quickly, the market falls or backfilling the building becomes a management nightmare. Just make sure your business can occupy the building for at least 5 years. If you expect tremendous business growth in the near future that will necessitate a larger facility, you are better off leasing until your business is more stable.
2. Are You Ready to Put Your Personal Assets on the Line?
Many business owners think they can just buy a building to house their company simply based on the strength of their business. While this is true for very large businesses, for most small to medium-sized businesses any bank will expect the business owner to guarantee the loan with their personal net worth. Like all real estate, commercial property goes through cycles and typically when there are a lot of new small buildings and/or office condos going up or being refurbished, the market is hot. You need to anticipate a downturn in the market. You can’t just bet on inflation forever, unless you have a tremendous amount of staying power to ride out a down market. In our modeling of buying vs leasing, don’t assume big appreciation. If it happens, that is a bonus, however run your models with minimal expectations of inflation.
3. What is the Cost Difference Between Buying a Commercial Property & Leasing?
You may be surprised to know that most people who buy their own building for their business never do a comprehensive cost comparison of buying vs leasing. They just decide, “I want to buy my own building” and move forward. Before too long they’re emotionally tied to the concept of buying and may even get stuck buying a building due to business and time constraints. You’ll not only need to consider the price of the building, but also the cost of any improvements, the closing costs and loan points, all ancillary and continuing costs like taxes, insurance, utilities, association dues, maintenance, janitorial, common area expenses, etc. Also, don’t forget to include the opportunity loss of your down payment if it were otherwise invested. Put it all in a model and compare it against a comparable building that is available for lease. More often than not, the all-in cost of owning is quite a bit higher on a monthly basis than leasing a comparable building. yes, you can offset the costs with tax savings, structure depreciation and possible asset appreciation, but typically unless you plan to hold for a long time (5-10 years +) or unless appreciation is rampant, the cost of ownership will likely be higher in the short run.
Buying Your Own Commercial Building – A Few Basics
So now with a full understanding of the points above, if you still want to buy a building, here are some basic tips & processes of buying a commercial property, building or office condo:
1. Financing – Most small businesses today buy their buildings through SBA funding. You still go through a bank or lending source, but the loan is ultimately split and the SBA finances a portion of the loan (usually a little less than half). The advantages of an SBA loan are 1.) long term – up to 20 years, 2.) a low rate – typically about 1/2 point lower than a bank rate, and 3.) a low down payment – usually about 10%. The primary disadvantage of an SBA loan is that the points to fund the loan are high – usually between 2.5-3 points on the SBA portion of the loan (note: often the points can be rolled back into the loan). Lastly, in addition to financial qualifications, to qualify for an SBA loan, a business typically needs to occupy at least 50% of the building/office condo being purchased. Conventional financing is an alternative, but the rates will be higher, the term will be shorter, and the required down payment will be higher. Just like buying a home, it is a good idea to get pre-qualified before you begin your search for a new commercial building.
2. Improvements – Most buildings require some improvements to be properly outfitted for a new business. Some buildings just need to be refurbished internally, some need to be built out from shell condition, and some require major retrofit and renovation. Regardless of the situation, most small business owners grossly underestimate the cost of the required improvements for their new office building. Please understand that a full office build-out on a small shell building with a high level of finish can easily exceed $100 sf. On the other hand, carpet and paint is usually only around $5-7 sf so the question of the cost of improvements is variable. Bottom line, get several contractors to bid on your plans before you close on the building. Don’t take anyone’s word for it as nobody can eyeball estimate a substantial construction job, even if they tell you they can
3. Negotiating the Offer & Contract – Most small business owners can negotiate the price fairly effectively. However when it comes to negotiating the contract they do a lousy job (unlike residential real estate, many commercial contracts are not standard). Make sure you read the contract and have a professional take a look at it with you, otherwise you may find yourself in a horrible pickle.
4. Due diligence – Due diligence begins following execution of a proper purchase and sale agreement and continues until the opening of escrow. This period is critical for you to complete all of your investigations on the building and to ensure that financing of the deal on the table can be arranged, so don’t make this period too tight and make sure that you complete your investigations before your deposit becomes non-refundable and escrow opens.
5. Escrow – In terms of escrow, once escrow opens, most small business owners just sit back and expect escrow, title, appraisal, and the bank to coordinate efforts to get the deal closed. Someone in your camp needs to babysit the escrow period to ensure that everything goes smoothly and that any hiccups are dealt with quickly.
Now that we have given you some of the basics, we are going to share the real key to buying commercial properties, buildings, and office condos. The simple solution is this; do what all of the experienced, larger companies do….Hire a commercial real estate expert to help you. It won’t cost you a dime, in fact you will get a better deal, the majority of the work will be done for you and you will be better protected from the pitfalls of buying a commercial building.
Most business owners/operators are “do it yourselfers” by nature, so it’s no wonder that many try to buy commercial buildings on their own. Most figure it is not that difficult and if they deal directly with the owner they can save money by cutting out the commission.
This layman commission logic my appear sound but in reality it’s wrong. In pretty much all cases the commission won’t be saved by going direct and trying to do so will cost you both time and money; in fact it could cost you thousands. The bottom line is that in the world of commercial real estate, there are virtually no for sale by owner opportunities. Most properties are listed by brokers. Therefore, if you go directly, the listing agent just gets paid double to negotiate against you. Don’t be fooled by dual representation. If you don’t have a broker representing your needs exclusively, you don’t have representation and nobody is on your side.
What a Qualified Commercial Real Estate Agent Can Provide
There is only upside to having a qualified commercial real estate expert protect your interests in buying your new commercial property. However don’t make the mistake that many business owners make. Don’t work with a bunch of brokers to find your building, just work with one. Working with several brokers means sporadic assistance and a piecemeal, hodgepodge of opportunities thrown at you. Ultimately, you will never get the committed service focus and attention that any commercial property search and purchase requires. On the contrary by selecting one qualified, full service broker you will get focused attention, will see every opportunity and will get the type of service you deserve.
1. Full Coverage of Opportunities – A commercial real estate expert has loads of information that you don’t have, and one of their primary jobs is to source every property that could potentially fulfill your needs. Trying to do this yourself would result in a bunch of missed opportunities and tons of wasted time.
2. Needs Analysis – A commercial real estate expert can help you understand your needs more completely. As mentioned before an understanding of whether buying is right for you is key and a comprehensive cost comparison of leasing vs buying is a must.
3. Surveying properties and Tour Scheduling – This is where a commercial real estate agent can save you a tremendous amount of time. Locating all the alternatives, helping to narrow them down to the real candidates, and then setting an efficient tour for all of the properties is easy for a commercial agent, but would take you way too long on your own.
4. Protecting you from Buying Errors – Most do it yourselfers focus strictly on price. However there are many hidden costs and issues in any transaction that can far outweigh the purchase price. A commercial agent can point out the hidden costs to you and can reduce or eliminate any nasty surprises that often arise during the buying process.
5. Transaction management – A good commercial real estate expert will efficiently orchestrate your transaction so that you don’t have to worry about missing the myriad of little issues that can and often will arise. They will lead you step by step through the process and will coordinate with the various parties involved to ensure a smooth transaction.
6. Saving you Time and Pain in the End – Whether it be space planning, construction budgeting and management, phone and data installations, furniture acquisition and installations or even moving, a good commercial real estate expert can connect you to the best vendors in each category. Seamless coordination of these elements leads to a smoother, more hassle free new office experience.
7. Your Expert For Life – The best commercial realtors are in the business for the long haul. They want to see your business succeed and grow so they can work with you again and again. They can even become part of your business mastermind group that gives you insight and feedback in their area of specialty to help you achieve your business goals.
A qualified commercial real estate expert can do all the above for you to save you both time and money, but even greater than that, they can give you the peace of mind that you will have found and negotiated the best deal possible and that you have been protected from the pitfalls of buying a commercial property, to which many companies fall victim.