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Commercial Real Estate - The Hidden Trap

October 18, 2017

Commercial Real Estate – The Hidden Trap That Turns Your Investment Into a Las Vegas Crapshoot

There is a hidden trap that many commercial real estate investors are not aware of. Not being aware of it will quite possibly cause them to experience big monetary loss.

A substantial number of commercial real estate investors will try to get the biggest loans possible to acquire as much property as they possibly can. Their commercial real estate investments turn into a Las Vegas crapshoot because they over extend their investments and are spread too thin financially. This over-leveraging has a major blind spot or “minefield” in it. And that is no preparation for the things that go wrong in commercial real estate investment. Things that go wrong can have catastrophic financial consequences.

This problem is especially a problem for the new commercial real estate investor. Lack of experience and lack of financial awareness regarding commercial real estate is a set up for financial failure or at best – a lot of financial stress from a “roller coaster” of handling financial crisis.

It needs to be stated that there are experienced commercial real estate investors who should know better, yet will over extend themselves financially too. This type of investor is so mesmerized by the blinding spell of making quick money, they succumb to the Las Vegas mindset just as the inexperienced investors do. They may have even experienced big financial loss in the past.

I believe that acquiring wealth is a process along the lines of the fable of “The Tortoise and The Hare”. You build wealth gradually by moving steady like the Tortoise. Year after year you build momentum of wealth. In the beginning, you have very little momentum. But, after quite a few years you could achieve massive momentum and “win the race” – the achievement of financial independence.

The Hare’s thinking causes failure. He thinks he has already beat the tortoise and he can just take a nap. The commercial real estate investor with the Las Vegas mindset also takes a kind of a “nap”, a “nap” in which he is mentally “asleep” not looking at the things that can go wrong in real estate investment. These things include:

Real estate going down in value at some point. It is a fact that real estate will go down in value at some point. This is because it is cyclical in nature as so many things are. Many things go up and down.

There will be recessionary periods where occupancy will drop, rents may go down, and property values will decline. This means declining profit. A severe recession can cause losses for millions of real estate investors.

But, the inexperienced mesmerized investor will typically not be aware of this cyclical nature of real estate. They only envision profits continually increasing and increasing and increasing. When the down cycle occurs, many of them are surprised and shocked, not seeing that they put the “blinders” on to block out reality. They are addicted to the affliction of blame. They do not take responsibility and do not see themselves as accountable for how they caused their losses to occur.

Preparation is so important. Many of these investors did not prepare for the low part of the real estate cycle. Hypnotized and lured by the “Siren” like thoughts of get-rich-quick, they are blind to the realities and laws of finances and economics.

Here are some things that can occur when the commercial real estate investor does not prepare for things that can happen on the down side.

1. A declining neighborhood can occur. A commercial real estate investor could buy a property when the property is on the increase in value in a neighborhood. But years later that same neighborhood could start to decline for many reasons. Perhaps other neighborhoods in the region become the newest rage for apartment dwellers and the small businesses that follow them as they move into the area. Or perhaps the particular area is experiencing an economic decline because of higher unemployment.

Now the investor watches as quite a few of their tenants stop renewing their leases, and it becomes increasingly difficult to get new renters. Profits plummet for the investor.

The investor who has the Las Vegas mental attitude will most likely not have the savings to withstand such an onslaught and is very vulnerable to losing the property.

2. Deployment in a military town. Some real estate investors fail to know that there could be a big risk if they have a good number of military tenants. A deployment could occur and leave the investor with a big financial loss.

3. A region with only one major industry for employment. This city is very economically dependent on this one industry. If this industry should have a big decline, thousands of people are vulnerable to job loss.

I live in Texas where this occurs quite a bit in the oil industry. When oil prices drop strongly, the oil towns such as Odessa and Midland suffer. Many people are laid off, businesses close, people move away and real estate plummets.

Another example is in the lumber industry in which I had a big financial loss involving a real estate investment of mine and a partner. It was 1979 when Springfield, Oregon (a lumber town), experienced a severe recession. I lost three investment homes I owned. The tenants couldn’t pay their rent. A real estate investor needs to be aware of this problem, and not buy property in an area that is dependent on one industry. The exception is the experienced real estate investor who has the knowledge and capital to purchase properties in a declining area when the prices are way down.

4. Sudden unexpected major repairs. The inexperienced investor, especially the one with the Los Vegas mental attitude, may not have the savings for handling problems such as a sudden major plumbing problem that costs $40,000 to repair. Or perhaps a roof is at a point that it has to be replaced, and it will cost $70,000.

5.Poor quality property management. An inexperienced commercial real estate investor having inferior quality property management notices that the occupancy has dropped suddenly in her apartment building. She trusted her property manager, but it turns out that he became very lax and did not carry out his responsibilities of getting new tenants. The investor now is experiencing a significant drop in rents collected.

This particular real estate investor does not know how to manage their property manager. See our article about managing your property manager here

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Bruce Painter, Director of Marketing, Business Loan Store