How To Buy Commercial Real Estate

Every so often, I think it’s important to help business owners and investors think about the various aspects involved in buying commercial real estate. Below are some questions and thoughts to consider.

Assuming you haven’t owned commercial real estate before, run a lease versus purchase analysis to see if there is a cost benefit to ownership. A qualified commercial real estate broker can help with the analysis. When looking at a 10-year timeframe and assuming a modest annual increase in property value, you might be surprised at the amount of overall financial gain from ownership versus leasing, especially in a relatively stable and growing market like Central Texas.

Do you have enough cash or financing to purchase? If you occupy 51% or more of the property, that is considered owner-occupied and may qualify you for the best financing in terms of down payment, interest rate, length of loan, etc. Typically, you can put down as little as 10-15% of the property value with good credit. For an investment property, you will be looking more like 25% down (or more depending on your credit score). You will also incur costs associated with the feasibility phase of the purchase, including a building inspection and possibly a phase 1 environmental assessment and appraisal.  These are not large expenses; you just need to be aware of them. In addition to the down payment, you need to consider what improvements need to be made to the property to satisfy your needs. Many lenders have financing programs that include the improvement expenses.

If you have a unique requirement or have the time and patience, you can consider constructing a new building. While it can be extremely satisfying when it’s all said and done, building from scratch takes many months to plan. If going this route, make sure you have competent advisors.

If you buy commercial real estate, you (or someone associated with you) will sell it one day, so always think about your exit strategy before you purchase a piece of real estate.  If there are issues or concerns today that are not rectified like inadequate parking, out-of-date architecture, dysfunctional floor plan, limited zoning, flood plain issues, etc., then the day you go to sell, these could all be issues for a potential buyer.   

Buying commercial real estate is often a complex process. You’ll likely need to hire experts. At the very least, you’ll need to hire a commercial real estate broker, accountant, lender, and commercial real estate lawyer. If the property needs renovating, you will want to bring in a contractor for pricing purposes. If you’re adding to an existing building or building from scratch, bring a civil engineer and architect to the team to understand the zoning, setbacks, impervious cover, height restrictions, fire code hurdles, potential parking, etc.

Understandably, many people are curious about available properties to “wet their appetite” before they get too serious about the process. Have your commercial real estate broker run a report of listed properties that fit your parameters. If you see a few properties that peak your interest, you’ll want to understand the financing side of things before you go any further.

Your existing banking relationship is a good place to start. Most lenders, whether credit union or traditional banker, have a commercial loan group. They can provide you with information on the loan qualification process and terms. Keep in mind that local and regional lenders can be more aggressive (in a good way) with loan terms than the big banks, so be sure to shop around. Another avenue for financing is through a mortgage broker who will do the shopping for you and find the best terms that match your financial situation with the appropriate lender.

Once you have searched the market and found the perfect property, you have several ways to make the offer:

1. You can have your commercial real estate broker draft a Letter of Intent (LOI) outlining the offer price, financing terms, time frame for title review, survey, inspections, etc.
2. Have your commercial real estate broker fill out a commercial real estate promulgated contract (for Texas it’s a form issued to Realtors by the Texas Association of Realtors)
3. Have your commercial real estate attorney draft a sales contract

All options are usually acceptable, but in a competitive situation with multiple buyer interest, submitting an actual contract is the most aggressive way to get the property off the market. With any approach, be sure your qualified attorney reviews the document and explains the details of the agreement, so you know exactly what your rights and obligations will be.

This is where it gets a little more real because money is about to change hands. Once a contract is executed, the clock starts ticking. You only have so many days for review (or Due Diligence) to know as much about the property as you possibly can.

Contact your lender to start the loan process. They will need a copy of the executed contract and will ask for various documentation. You will want to line up a property inspection. Your lender will set up the appraisal and, if required, the phase 1 environmental inspection.

The seller will submit an existing survey (if they have one) to the title company for their approval. If the survey is not acceptable or available, the party responsible for ordering a new survey will need to do so as soon as possible since they can take a few weeks to schedule. As information comes in on the property, you will want your experts to review the documentation to determine if any further action is required.

If something strange or wrong comes up in your inspection of the property, review of the title, or survey that is unreconcilable, you have the right to cancel the contract and get your earnest money refunded. 

Once you are satisfied that the property you are buying meets your needs and doesn’t have any “deal killing” issues and you have past the feasibility stage, you are in the “pre-close” stage. During the pre-close stage, you are primarily working with your lender on firming up the financing. If your property will require repairs or modifications, you will want to meet with your architect and contractor to line up the work needed so once you close your contractor can hit the ground running. Right before the close, don’t forget to contact all utility companies to transfer over utilities. High speed internet access such as T-1 and fiber can take up to 30 days to install.

At the closing table, make sure you get all the keys and security equipment information so you can access the building and rekey/recode everything.

After the closing, you have the obvious task of moving your personnel and equipment.  Keep a folder for the property with the closing documents, maintenance contracts, plans, building insurance, etc. for future reference.

I hope you find this article helpful. If you have any questions or would like to discuss your situation in more detail, do not hesitate to contact me at 512-736-5933 or my email at oddo@toweratx.com.