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Real Estate – Commercial Properties
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Tax reform took away some of the benefits of owning commercial property. Overbuilding and poor economies in many areas are compounding the troubles brought on by the loss of those tax advantages.
Although those changes have hurt some investors, they also created a buying opportunity for you. Many good-quality buildings are now for sale, in part because their owners relied too heavily on big tax breaks to make their purchases worthwhile. With those tax benefits now eliminated or reduced by the new legislation, those owners are anxious to sell their buildings at attractive prices. By properly evaluating those and other commercial properties — focusing on their economic viability, rather than the tax breaks they'd generate — you can realize good monthly cash flow and handsome profits when you eventually sell.
The main consideration, once again, is the location of the property. If the building is wrong but the location is right, you can renovate the structure or raze it and start over. But if the location is wrong, there is absolutely nothing you can do.
Location is also essential to the property's future appreciation because rentals, upon which future value can be based, are to a large degree influenced by the location. In any case, the land under the building could be a major source of any increase in value.
The value of location
Many of the benefits derived from owning well-located commercial properties haven't changed even though the tax laws have. Among those benefits:
- You can buy a relatively large asset with relatively little money and then pay for the balance with long-term loans.
- Well-located commercial structures with most of their space leased often have an immediate positive cash flow and a rate of return that is better than returns from residential property.
- There is an excellent chance of appreciation over time and an opportunity to refinance and mortgage the property for more than you actually paid for it.
- Good commercial property is fairly liquid, meaning you can often quickly convert it to cash by selling it.
- Unlike some residential rental properties that are subject to rent controls, commercial rents are usually set by market forces not politicians.
- Commercial leases are often on a net basis, which means that the tenants pay their own utilities, taxes and improvements.
- It’s usually easier to get legal relief for nonpayment of rent from a commercial tenant than it is from a residential tenant.
If you decide to explore the purchase of commercial property, a key factor to keep in mind is that buildings that are empty at the time of purchase generally make poor investments for anyone who isn’t a full-time real estate professional.
Special types of commercial properties
How about becoming a silent partner in a car wash, distributorship or a small plaza? In effect, this is what you become when you invest in one of these properties and rent to a commercial tenant. You do, however, have the added security of the property. Investments in car washes and distributorships present special concerns that aren't involved in most other types of real estate deals. For example, such endeavors usually entail hiring more people and dealing with more government agencies than you'd have to be concerned with if you buy an office building. Investing in a small plaza, on the other hand, is much like investing in other mainstream commercial properties. Some general rules that apply to car washes, distributorships and plazas alike are outlined below.
How important is traffic?
Once again, the most important factor in determining how successful such an endeavor will be is its location. If the tenant's business depends on traffic flow, make sure the suggested property has it.
Check out main traffic arteries, exits, parking and the location of the competition. If you think that's the tenant's job — that all you need to do is provide the money to buy the land and building — you are wrong.
The future appreciation of your property and the rents you charge depend on the selection of a good spot. So get involved, and don't just accept the tenant's word.
It's also important to determine the creditworthiness of your tenant. Check it out before you get involved. Has the prospective tenant been a good entrepreneur, or has he had serious credit problems?
Assuming the tenant is creditworthy, what should you expect in return? Normally, you make a 25 percent down payment toward the purchase and get a loan for the balance. The tenant signs a lease for five or 10 years, taking on all costs of operation except for mortgage payments, property insurance and major renovations.
You collect your rent and pay off the mortgage. Although your return will vary with the situation, you should expect a 5 or 6 percent cash flow return on your money in addition to a steady appreciation in the value of your property.
Are you willing to gamble if it could increase your return? If so, many tenants will give you a percentage of sales rather than a flat rental fee. The idea is that if they have a bad year, they pay less. If they have a good year, they pay more. If you've bought a good property because you've done all your homework, you can probably make more money by taking this added risk.
Gas stations and fast-food outlets
With a few exceptions, these are two areas that have badly stung many investors in the past. Once again, such failures were mainly due to poor locations or too much competition in the area, too many people thought all they needed to do was to buy the place or build the place. They were wrong.
This doesn't mean you should avoid investing in such business establishments. However, you should invest in them only if you're willing to take a greater risk than is entailed in most other real estate ventures.
Operators in prime locations are making a good return, and you can too. Certain chains, such as Kentucky Fried Chicken, have a reputation for attracting customers. The potential exists for you, but check it out carefully — not every proposition is a good one. If you decide to enter into an agreement, try to get a long lease and have the chain sign it, not just the local operator. The returns should be similar to those of car washes and other operations discussed in the previous section.
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