Commercial Real Estate Investment Decisions

WEIGH YOUR RISKS CAREFULLY

When you decide to embark on a commercial real estate investment program, how do you get your start? We know that there is no such thing as 100% financing for commercial property, so where do you get your initial capital for that first purchase? One method which I have discussed before is to use Other People’s Money as your initial “stake.” Perhaps having partners is not the path you wish to follow in your investment program. That makes the other option using your own funds. Before you dip into your resources, however, consider some of the risks you face.

First, you are embarking on an investment program about which you have little practical experience. You may have read every book on commercial real estate investing ever printed and gone to every seminar ever produced in a hotel for a year, but you have no experience in the business. Do you really know what can go wrong? Do you realize what additional reserves you might need in case things don’t go as planned?

Second, consider the source of your equity. For most people who have done some real estate investing, they have probably focused on residential investment properties. Residential properties usually enjoy a large number of comparables to easily estimate value, financing programs for residential properties allow potential buyers to facilitate sales with little equity investment, and residential properties are usually less expensive, and therefore more accessible, to most people. If you are such an investor, then you probably have a pretty good pool of equity to tap. But how do you access it? Sell them outright and pay your capital gains? Sell them in a 1031 Exchange? Refinance them? Each option has its advantages and disadvantages.

Third, if you are like most people, your biggest chunk of equity is sitting in your home. There may be a great temptation to go get yourself an equity line, suck out the equity, and go buy a commercial property somewhere. Before you do, make sure to consider how the increased debt service of the equity line will affect your finances. Can you truly afford the payments if something doesn’t work out with your commercial investment? Yes, your commercial property will be producing income. However, the majority of that income will be used to pay its operating expenses and paying off the loan you arranged to acquire it. That doesn’t leave a lot left over for you in the initial years of the investment to pay down the equity line, which will most likely have a rate somewhere above the Prime rate (8.25% today).

The point is to consider your investment goals, your tolerance for risk, and your ability to live without the funds you are using for your commercial investment. Over time, your commercial portfolio should provide you with significant current income, a hedge against inflation, and net appreciation. You need to pay careful attention to how you structure your commercial real estate financing to minimize unforeseen risks and increase your chances of success. In your quest to achieve your commercial investment goals you need to carefully asses the impact of the financing decisions you make.