Which Types of Commercial character Should You Invest In?
When it comes to commercial real estate investment, investors often want to know which types of similarities they should consider investing in. This article discusses about 5 groups of similarities and reasons why you should or should not consider them.
1. Land: the people who invest in raw land often hope to buy agricultural land near commercially-zoned land at a few thousand dollars per acre. They dream their lot will be re-zoned to commercial in the near future which is worth hundreds of thousand dollars or more an acre. People who convince you to invest in raw land often try to sell you this dream. While this dream truly happens just like it’s possible to hit the jackpot in Las Vegas, the reality is most investors lose money or get little return in land investment. It is a very risky investment as land generates either no or very little income. From an income tax viewpoint, land does not depreciate in value so you cannot claim depreciation. On top of that the interest rate to land loan is also very steep compared to other types of commercial similarities. So each month, you would need to come up with money to pay for the mortgage while collecting none. You should consider invest in land if you
– Know how to develop so you could transform raw land into a shopping center.
– Know exact what you do and have thorough pocket.
– Own the land of a shopping center (you don’t own the buildings).
2. Apartments: this is a management intensive investment as the turn over rate is high. The leases are short-termed often at one year of month to month. As tenants move in and out, you would need to use money to get the unit ready for occupancy. Apartment tenants tend to have higher late payments history than other tenants as they are more often have a tighter budget. If you don’t like the headaches dealing with lots of tenants, you probably want to stay away from apartments. The meaningful to successful apartment investment is to
– Control or minimize the expenses. This may sound like a unimportant task until you see the expense list provided by the character manager. These expenses include: advertising, accounting, bank fees (for insufficient funds), capital improvement, coin laundry subsidy, cleaning, collection fees, garbage disposal, insurance, landscaping, legal (eviction) fees, maintenance, offsite character management, onsite character management, pest control, painting, repairs, sweeping, security, character taxes, utilities and water.
– Invest only in similarities in a good location with no deferred maintenance.
– Stay away from areas with rent control, e.g. Berkeley, Los Angeles.
Otherwise you may end up getting little cash flow or already having negative cash flow. If one of your investment objectives is to get high cash flow, you may want to stay away from apartments. In California, if you own a 16 or more units apartment you must have an onsite manager. This increases the expenses further. In general, apartments are easy to buy and harder to sell. There are always lots of them on any markets. The upside about apartments is they tend to have high occupancy rate as everyone needs a roof over their heads. Due to this fact the interest rate for apartments is often ¼- to ½ percent lower than other commercial similarities.
3. Special Purpose similarities: These are similarities designed for a specific business, e.g. restaurants, gas stations, and hotels/motels.
– Restaurants: some investors like to invest in brand name fast food restaurant like Burger King, Pizza Hut, Jack In The Box, KFC. These are single tenant similarities with long term absolute triple-net lease which often require no management responsibilities from the landlord. However, the rental income or cap rate for these restaurants is often lower in the 5-7% range. Emerging regional brand name restaurants like Johnny Carino’s, Back Yard Burger, Zaxby’s or Tia’s TexMex tend to offer higher cap rate in the 7-8.5% range. However, when you look deeper in the financial statements they may not make a profit however. The restaurant operators sell the real estate to investors higher cap rate and lease back the character for 20 years. They in turn use the sale proceeds to expand their business by building more restaurants. So if you are willing to take higher risks, you will be rewarded to high income with these emerging restaurants.
– Gas stations: when you buy a gas stop, you buy both real estate and the gas stop business. Most gas stations also have convenience stores and sometimes several car repair bays. The profit margin for gas is fixed at 10-20 cents per gallon [many customers wrongly blame the high gas prices on the innocent gas station operators] but is pretty high for convenience store. This is considered an owner-occupied character which qualifies you to a SBA loan with as little as 10% down payment is required. If you don’t plan to get involved in running the gas stop, auto repair and convenience store business, you may want to stay away from gas stations as gasoline is a chemical that could contaminate the soil. Once a leakage occurs and contaminates the ecosystem, it takes years and lots money to clean up the soil. You may already be liable to damages from owners of nearby similarities as contamination may spread out to their similarities. It’s almost impossible to sell your character as no lenders want to loan the buyers the money to buy it.
– Hotels/Motels: once you buy a hotel/motel, you buy the real estate and a 24-hour-a-day 365-day-a-year business. This business requires hard work, and marketing skills to get the rooms filled. The rooms are worthless if they are vacant. The business tends to be seasonal and may be affected closest by economic downturns and political events, e.g. 9-11. Many of these similarities are owned by Indians with the last name Patel as they seem to work harder and know this business well.
4. Office Buildings: these similarities are single or multi-story buildings. The older two-story office buildings without elevators tend to have trouble finding tenants on the upper floor as many service businesses may have physically-challenged customers who cannot walk up the stairs.
– Single-tenant buildings: the similarities are used as corporate headquarters of big corporations like Cisco. These big buildings tend to be more sensitive to the economy. Once vacant, it’s hard to find a substitute tenant.
– Multi-tenant buildings: these similarities are leased by small businesses, e.g. real estate, tax accountants. Investors who buy these similarities want to spread out the investment risks. When one tenant vacates a unit, you lose just a small percentage of rental income.
– High Quality Tenants: most of them have good credits, lot of assets and promptly pay the rent when due.
– Leases: The leases for office building vary from complete service [landlords pay property tax, insurance, maintenance and utilities] to NNN [tenants pay property tax, insurance, maintenance and utilities]. The NNN lease is a litmus test on whether the office building is in high need by tenants or not.
– Medical buildings: these similarities are leased chiefly by doctors and dentists. A good medical building should be in front of or across the street from a hospital. This makes it functional for doctors to go back and forth between hospital and their offices. Some investors prefer medical buildings as medical tenants are very recession proof.
5. Shopping/Retail Centers: These centers are mostly single-story and can adjust to wide varieties of tenants: retail and service businesses, restaurant, medical, school, and already church. As a consequence, this is the most popular kind of commercial similarities that investors look for. They are always in high need as there are more buyers and few sellers.
– Multi-tenant strip: the advantage of this investment is when a tenant moves out, you only lose a portion of the total income while you are looking for a new tenant. So you spread out the risks in this character.
– Single-tenant building: The advantage is you just have to work with one tenant. Some of the tenants, e.g. Costco, Home Deport, Walmart, CVS Pharmacy sign 10-20 year lease and guarantee with their corporate assets which could be worth billions of dollars. This makes your investment very safe.
– High Quality Tenants: most of them have good credits, lot of assets and promptly pay the rent when due. They often sign long term 5-30 year leases so you don’t have worry about finding new tenants every year. They keep your character in good condition and sometimes already use their own money to make it look better in order to attract the customers to the stores.
– Triple Net (NNN) Leases: the leases for retail centers are often in favor of the landlord. The tenants pay a base rent and reimburse the landlord for character taxes, insurance, maintenance and sometimes already character management fees. This takes away a lot of risks from you as an investor. The NNN lease in a sense is a litmus test on whether the character is in high need by tenants or not.
– Ground Lease: sometimes a retail center with ground lease is for sale. When you buy this center, you only own the improvement but not the land underneath. It could be a trophy character but you should think thrice about investing. Once the ground lease expires and the land owner refuses to extend the land lease, you own nothing! So it’s easy to buy this center but very hard to sell.