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What types of commercial property should you invest in?

When it comes to commercial real estate investments, investors often want to know what types of properties they should consider investing in. This article is about 5 groups of properties and the reasons why you should or shouldn’t consider them.

1.Ground: People who invest in virgin land often expect to buy farmland near commercially zoned land for a few thousand dollars an acre. They dream that their lot will be rezoned as commercial in the near future, which is worth hundreds of thousands of dollars or more per acre. People who convince you to invest in virgin land often try to sell you on this dream. While this dream actually happens as if it were possible to hit the jackpot in Las Vegas, the reality is that most investors either lose money or get little return on their land investment. It is a very risky investment as the land generates little or no income. From an income tax standpoint, the value of land does not depreciate, so you cannot claim depreciation. In addition to that, the interest rate of the land loan is also very high compared to other types of commercial properties. Therefore, each month, you would need to get money to pay the mortgage without charging anything. You should consider investing in land if

– Know how to develop in order to convert vacant land into a shopping center.

– Know exactly what you’re doing and have a deep pocket.

– Own the land of a shopping center (you do not own the buildings).

2. Apartments: This is a management intensive investment as the turnover rate is high. Leases are short term often to one year from month to month. As tenants come and go, you’ll need to spend money preparing the unit for occupancy. Apartment tenants tend to have a higher past due history than other tenants, as they tend to be on a tighter budget. If you don’t like the headaches of having to deal with many tenants, you probably want to stay away from apartments. The key to a successful apartment investment is

– Control or minimize expenses. This may seem like a trivial task until you see the list of expenses provided by the property manager. These expenses include: advertising, bookkeeping, bank fees (for non-sufficient funds), capital improvements, money laundering allowance, cleaning, collection fees, garbage removal, insurance, landscaping, legal (eviction) fees, maintenance, property management off-site property, on-site property management, pest control, painting, repairs, sweeping, security, property, utilities and water.

– Invest only in properties in a good location without deferred maintenance.

– Stay away from rent controlled areas eg Berkeley, Los Angeles.

Otherwise, you may end up getting little cash flow or even negative cash flow. If one of your investment goals is high cash flow, you may want to stay away from apartments. In California, if you own an apartment with 16 or more units, you must have an on-site manager. This further increases expenses. In general, apartments are easy to buy and more difficult to sell. There are always a lot of them in any market. The advantage of apartments is that they tend to have a high occupancy rate, since everyone needs a roof over their heads. Due to this fact, the interest rate on apartments is typically ¼ to ½ percent lower than other commercial properties.

3.Special purpose properties: These are properties designed for a specific business, such as restaurants, gas stations, and hotels/motels.

– Restaurants: Some investors like to invest in branded fast food restaurants like Burger King, Pizza Hut, Jack In The Box, KFC. These are single-tenant properties with a long-term absolute triple net lease that often does not require management responsibilities on the part of the owner. However, the rental income or cap rate for these restaurants is typically lower, in the 5-7% range. Brand name emerging regional restaurants like Johnny Carino’s, Back Yard Burger, Zaxby’s or Tia’s TexMex tend to offer a higher cap rate in the 7-8.5% range. However, when you look deeper into the financial statements, they still may not be making a profit. Restaurant operators sell the real estate to investors with a higher capitalization rate and lease the property for 20 years. In turn, they use the proceeds from the sale to expand their business by building more restaurants. So if you’re willing to take higher risks, you’ll be rewarded with high income with these pop-up restaurants.

– Gas stations: when you buy a gas station, you buy both the property and the business of the gas station. Most gas stations also have convenience stores and sometimes several auto repair shops. Gasoline markup is set at 10-20 cents per gallon [many customers wrongly blame the high gas prices on the innocent gas station operators] but it’s pretty high for a convenience store. This is considered owner-occupied property that qualifies you for an SBA loan with as little as 10% down. If you are not planning to get involved in running gas station, 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 leak occurs and pollutes the environment, it takes years and a lot of money to clean up the ground. You may even be liable for damages to adjacent property owners, as the contamination may spill over onto their properties. It is almost impossible to sell your property since no lender wants to lend buyers the money to buy it.

– Hotels/Motels: once you buy a hotel/motel, you buy real estate and a business 24 hours a day, 365 days a year. This business requires hard work and marketing skills to fill the rooms. Rooms are worthless if they are empty. Business tends to be seasonal and can be immediately affected by economic downturns and political events, for example, 9/11. Many of these properties are owned by Indians surnamed Patel as they seem to work the hardest and know this business well.

4.Office buildings: these properties are single or multi-story buildings. Older two-story walk-up office buildings tend to have trouble finding tenants on the top floor, as many service businesses may have clients with physical disabilities who cannot climb stairs.

– Single Tenant Buildings: The properties are used as corporate headquarters for large corporations such as Cisco. These large buildings tend to be more sensitive to the economy. Once vacant, it is difficult to find a replacement tenant.

– Multi-tenant buildings: these properties are rented by small businesses, eg real estate, tax accountants. Investors who buy these properties want to spread the investment risk. When a tenant vacates a unit, they only lose a small percentage of the rental income.

– High-quality tenants: Most have good credit, lots of assets, and pay rent when due on time.

– Leases: Leases for office buildings vary from full service [landlords pay property tax, insurance, maintenance and utilities] to NNN [tenants pay property tax, insurance, maintenance and utilities]. NNN’s lease is a litmus test of whether or not the office building is in high demand by tenants.

– Medical buildings: these properties are mainly leased by doctors and dentists. A good medical building should be in front of or across the street from a hospital. This makes it convenient for doctors to go back and forth between the hospital and their offices. Some investors prefer medical buildings as medical tenants are very resistant to recession.

5. Shopping/Retail Centers: These centers are mostly single story and can accommodate a wide variety of tenants: retail and service businesses, restaurants, doctors, schools, and even churches. As a result, this is the most popular type of commercial property that investors are looking for. They are always in high demand as there are more buyers and fewer sellers.

– Multi-tenant strip: The advantage of this investment is that when a tenant moves out, you only lose a part of the total income while you search for a new tenant. So you spread the risks on this property.

– Single tenant building: The advantage is that you only have to work with one tenant. Some of the tenants, eg Costco, Home Deporte, Walmart, CVS Pharmacy, sign a 10-20 year lease and guarantee their corporate assets that could be worth billions of dollars. This makes your investment very safe.

– High-quality tenants: Most have good credit, lots of assets, and pay rent when due on time. They often sign long-term leases from 5 to 30 years so you don’t have to worry about finding new tenants every year. They keep their property in good condition and sometimes even spend their own money to make it look better in order to attract customers to the stores.

– Triple Net Leases (NNN): shopping center leases are usually in favor of the landlord. Tenants pay a base rent and reimburse the landlord for property taxes, insurance, maintenance, and sometimes even property management fees. This takes a lot of risk away from you as an investor. The NNN lease, in a sense, is a litmus test of whether or not the property is in high demand by tenants.

– Land lease: occasionally a shopping center is sold with land lease. When you buy this center, you only own the improvement, but not the land underneath. It could be a trophy property, but you should think three times before investing. Once the land lease expires and the landlord refuses to extend it, you own nothing! So it’s easy to buy this center but very difficult to sell.


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