April 27, 2016
Welcome to Part 3 on Commercial Mortgages. The focus thus far has specifically been on mortgages. The previous week we went over four key points. Here is a quick summary:
- Thoroughly inspect the property – do your best to inspect each unit. This is because the units you do not inspect could have major costly problems.
- Inspect the neighborhood quality. The real-estate listing may say it’s a great neighborhood - but for example, a neighborhood has been devastated by a large plant closing resulting in much unemployment and low occupancies.
- Check if there have been recent rent concessions given to get high occupancy. This can cause deep financial loss if it is not inspected. The listing reads 95% occupancy – but 15 units were just rented with first month rent of $100. 11 of those tenants abandon the property within a few months because they can’t afford the rent, leaving the investor with a huge loss.
- It is incredibly important to manage your property manager. Just because you hire what you think is a great property manager doesn’t mean that you are bullet proof in the area of property management. Some property managers steal money. Some get lax and will not work hard to fill vacancies. Some will be lax in the care of the property.
For this current article, we have four additional points:
- Thinking that if you have residential property investment experience, you will easily be able to succeed in doing commercial property investments. If you understand the following concept, you will have a better chance to succeed: Commercial property investment is a “different planet” from residential property investment. There are quite a few major differences. We will be focusing specifically on multifamily investing (5 units and above).
One major difference is that with multifamily property investment, especially if you have a large number of tenants, you have the problem of being able to inspect renter care of all units, and also of the entire property. Some tenants may be severely damaging their apartments, and you do not discover it until they have left the property. It can be difficult to know what each tenant is doing to take care of their property and also of the building as a whole.
Another major difference is that you have to continually be on top of the maintenance of the property, including all systems. Spotting a water leak in a 100-unit property is much more difficult than in a residential home rental.
A third big difference is that you can have large expenses in running a multifamily property, and some of them different from running a residential property. You also are likely to have more unexpected expenses. If you are not prepared for these expenses, you could be hit hard financially. One such expense is a much greater number of repairs than you have in residential property investment, especially if the property is older. Another increased expense is legal for conviction, etc.
- Not knowing what your property is worth. An investor falls in love with a property and buys it largely based on emotion. This is a big mistake. (See part one of this series). She does not closely inspect the value of the property, but reads the real-estate listing which states an inflated future value. She also gets an inflated opinion of value from the selling realtor. The value of the property is actually quite a lot less than the asking price. She works out seller financing with the seller and pays way too much.
It’s important to deeply inspect the value of the property you are going to buy – see what similar properties are selling for in the neighborhood. Inspect if the neighborhood property is growing or declining in value. Make sure the property appraises well in your consideration of purchase.
- Not knowing your financial purpose and exit strategy. What is your purpose in purchasing a commercial property? It’s important that you have a clear purpose. Is it to have long term residual income? Is it to increase the value of the property through rehabbing it and then flip it. If you are not clear about your financial purpose, the long term consequences could be very negative.
Also, as part of this, what is your exit strategy? Do you want to keep it a short time and flip it. Do you want to keep it for 5 years, sell it, and upgrade to a larger property? Or perhaps you don’t want an exit strategy because you plan to keep it in the family for many years.
- Taking on too advanced of an investment strategy. An investor who has no commercial loan experience purchases a property that is in dire need of repair, and has 70% occupancy. He ends up getting a bridge loan and has an expensive rehab project. Because of his lack of experience, he greatly under-estimates rehab expenses, and also overpaid the workers who he had hired for the rehab.
He ends up with a big financial loss.
If you do not have experience in commercial investing, keep it simple. Just do a plain, simple loan. The exception would be if you have a partner with, for example, multifamily rehab experience and bridge financing if needed.
Contact us to see if you pre-qualify for our best multifamily, commercial, bridge, construction, or business loan rates and terms. Also, contact us if you would like to discuss your particular commercial lending needs, or if you have any questions. Call 214-695-7310, or send an email to email@example.com
Bruce Painter, Director of Marketing, Business Loan Store