Peter Harris - Commercial Real Estate Investing For Dummies

Does the property produce enough income to cover the expenses and mortgage?

What is the condition of the property?

What is the financial strength of the borrower?

Flip to Chapter 8to discover how to get your lender to say “yes” to your deal, what lenders like and dislike in deals, and tips on choosing the best loan for your deal.

Is commercial real estate risky? You bet it is. One of our mentors always said, “Anything you go after of great worth has great risk.” Commercial real estate investing involves big dollars and lots of people. And whenever you have lots of money and people working together closely, trouble is right around the corner. But risk is a facet of doing business — any business. You can’t avoid it. The best thing you can do to protect yourself is to understand all the risks that are possible, and then get your advisors involved to help you figure out how to avoid them. Don’t skimp on getting the best advisors you can hire either. As the saying goes, “It’s expensive being cheap.”

But here’s the good news: Risks can be managed to levels of great certainty. Being successful in commercial real estate nearly always means taking calculated risks. Are you willing to risk some of your time and money to be financially free? What if you could secure your family’s financial future? There are risks with everything you do in life. You may have heard of people who spend their whole lives trying to avoid taking any risks, and in the process, they accomplish nothing. What a shame. The point is that sooner or later you’ll probably have to step out of your comfort zone to free yourself from the rat race.

If you like to err on the side of caution, you may want to start out with a smaller multifamily building. Or maybe you want to roll the dice big time. In this case, check out Chapter 16for more on land development, which can satisfy the riskiest adventurer.

One of the risks of real estate investing is that if you aren’t careful, the property can fail. We include a whole chapter in this book ( Chapter 14) on why properties fail, because real estate investing and the decisions we make don’t always turn out well. Sometimes you just make a bad deal. And sometimes you may hire the wrong property management company. And other times the market may take a turn for the worse and send you in a downward spiral. Chapter 14may be the most important chapter you read because understanding why properties fail can enable you to spot where your property needs some help. Or, if you’re looking at a deal, knowing why properties fail helps you analyze why the property is in its current condition. And don’t forget that understanding why properties fail can put you in a great negotiating position and assist you in solving property problems.

The most feared risk in commercial real estate investing is getting sued. Every tenant you have can be a potential lawsuit. You can also be sued by contractors, city personnel, and the list goes on and on. How do you protect yourself? Here are two lines of defense:

Obtain property liability and hazard insurance.

Choose a protective form of ownership or holding, such as a limited liability company.

Limited liability companies (LLCs) are by far the most popular form of ownership used today to hold commercial real estate.

The worst possible method of holding title is to hold it individually in your name. This way, you have zero liability protection and absolutely no privacy.

In Chapter 13, we offer many tips and strategies for holding and protecting your property and assets. Your goal should be to build a “legal fortress” with the right experts.

In our years of investing and watching numerous successful and not-so-successful investors go at it, we have come up with several fail-safe measures (we call them common-sense measures!) for risk-proofing your investing. Here they are:

Do proper due diligence. Due diligence is the process you go through when verifying the financial documents of the property, performing a physical inspection, and checking out the legal pieces of the property, such as the title. Ninety percent of all deals die during due diligence. So, if you don’t do a thorough job, the consequences can be costly. You may end up buying a property that’s a money pit. However, when done properly, due diligence can actually help you make your sweet deal even sweeter. Reading Chapter 7, which provides the ins and outs of due diligence, may save you millions of dollars.

Don’t overpay. Overpaying is common among new investors. Don’t be the investor in a deal where the agent sets a record price on selling a property! If you’re buying apartments, make sure that you’re aware of what price you’re paying per unit. If you’re buying a shopping center, make sure you know how much you’re paying per square foot. In both cases, see what the recent market closings value your property at. Paying too much will lock up the property’s cash flow for a long time. (See Chapter 3for more on pricing your prospective properties.)

Have expert market knowledge. Knowing your market like the back of your hand sets you up for success. Before you close on your deal, make sure you know the following:How competitive your rents are with other similar local propertiesWhen and if there’s a “slow season” for rentals so you can plan aheadWhether there’s rent control in your city, which would inhibit you from raising rents as you thought you couldWe also like to inquire on crime statistics on the property in question by calling the local police department.

Hold your goals loosely. What we mean is that you should keep your investment’s exit strategy flexible at all times. An exit strategy has two parts, a plan to modify or improve the property and a method to sell or trade into another property. We like to have several exit strategies ready at any given time. Market conditions change. Your personal circumstances can change rapidly as well. So, don’t get wrapped up in executing just one exit strategy, because it may no longer apply.

Know where you are in the real estate cycle. There are four parts to any real estate cycle: expansion, contraction, recession, and recovery. By reading Chapter 2, you can figure out where your particular city is in the cycle, and you can determine when to buy, sell, hold, or bail. Each part of the cycle demands that you pay detailed attention to your investment decisions. Understanding real estate cycles helps you take the correct actions with the best timing. There’s nothing like timing the market like a pro!

You'll discover that controlling the risk in your commercial investments begins with finding good deals ( Chapter 5) and managing them well ( Chapter 12). Unfortunately, there's not one box that you can check off to eliminate risk. What you can do is learn to make good decisions so that you're acquiring stable properties which are much less likely to fail. (See Chapter 14.) You may have thought that risk-proofing was impossible, but you’d be surprised at what a little knowledge can do to your investment portfolio.