Investing in Commercial Property (Commercial Real Estate)

Broadly speaking real – estate can be classified as commercial, industrial and residential. Commercial Real Estate  is property used solely for business purpose.  It is any property used to produce income. Examples of commercial real estate include malls, restaurants, convenience stores  and office spaces.  Industrial real estate is used for manufacturing and production. Businesses that occupy commercial or industrial real estate usually lease space. Commercial and industrial real-estate is usually owned by investors who own the building and collect rent from each business (tenants). Similar to buying a business, investors should complete due-diligence before investing in commercial property. Key element of due-diligence include Location,  Property Type, Budgets and several other factors listed below.

Location

Location is a critical element of commercial property investing. Investors must understand the soundness of the location, demand / supply dynamics and vacancy  rates. Additionally, investors should ensure that job market, economy and population growth in the area is favorable. Without sufficient research they may land up buying  property in micro markets with high vacancies.

Property Type

There are different types of commercial property available  including retail, office space, industrial, multi-family and land .The most popular being retail and office space.   Investors looking for retail space have several options including free-standing street outlets and shops in malls.  These outlets can be as small as 500 – 1000 square feet. Shop in malls belong to a strata and are pre-sold to individual investors.

Industrial and commercial properties may have capital appreciation and rental yield.  Rental yield is the annual rent divided by the value of the property. Rental yield is critical element for valuing a property. A low yield implies the property is overvalued. Rental yield varies by country and market. For example, commercial properties with rental yield of 11 %to 12% is considered correctly valued in major Indian cities like Mumbai and Bangalore. Commercial property with yield less than that is considered overvalued.

Due – Diligence

In addition to the above factors Investors should check the credentials of the developer, potential infrastructure development in the area, access to public transport and quality of property management. In case of a retail store front -age and visibility are critical.

The buyer usually provides the seller a due diligence checklist.  The checklist includes request for information related to tenant information, building information, operating information, financial information and other miscellaneous items. Tenant information include rent roll showing the rents paid. Rent information must include tenant’s name, suite number, size of premises and several other attributes. Operating information should include financial statements of the property for the  past three years, current operating and capital expense budgets for the property, utility bills for the last three years, tax bills and more. Financial information includes understanding the break-up of cash flows. This includes collecting data on vacancy factor, maintenance expenses, property tax, building insurance, lease term, lock-in period and expiry dates for leases, long-term capital appreciation potential, cost of refurbishment and potential for refinancing. Additionally, the buyer should obtain new third party inspection report and title report.

Whatever information is provided by the seller, they usually include a provision in the purchase agreement stating the information contained in the documents must be verified by the buyer. It does not constitute a representation of warranty of the seller as to their accuracy.