Buying Commercial Real Estate?

Buying Commercial Real Estate?

In a recent post here, we noted that rock bottom interest rates and suppressed real estate values make this a wonderful time to buy a home. Does that same logic apply to the acquisition commercial property? The simple answer is that different rules apply to purchasing commercial as opposed to residential real estate. Let’s consider some of the factors.

The Motive: The primary reason for purchasing a home is that you like it, and owning it will make you feel good. Sure, we know all that stuff about the interest payments being tax deductible, and over the long term, home ownership can be like a savings account and so on. But the bottom line is that you want to live there. In contrast, the first rule of commercial property buying is, “do not fall in love with it.” This is an investment, and it must be analyzed as such.

The Price: All things being equal, you can always pay a little more than you intended if you really love the house. After all, over the long haul, inflation alone should get you back the purchase price and more. However, paying for the “future value” on a commercial property is a “no-no.”  One hopes that the cash flow (rental incomes) will increase over time. But why pay the seller for incomes you will have to generate? In the word of commercial property the old adage “the property is worth its cash flow” must prevail.

The Returns: The argument is sometimes made that home ownership can be cheaper than renting. In the strict sense (meaning what are the monthly payments?), there are times when renting is more costly than the monthly payments for a mortgage. However, one of the greatest “returns” of home ownership is “pride of ownership,” something that is not readily measured in dollars and cents. In the world commercial property ownership, the returns – typically meaning cash-on-cash return on investment – can and should be measured very precisely.

So, if you think you are ready to enter the world of commercial property ownership, start by forgetting all the things that guided the purchase of your last home. Don’t fall in love with it. Yes, of course, condition counts. Do not pay top dollar for a fixer-upper. But, first and foremost, do the math. Take a good commercial real estate broker to lunch, and ask him/her to show you how the math works, and how to do a financial analysis of that interesting investment property.