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3 Ways to Buy Commercial Real Estate At Minimum Risk

It’s not unusual for investors who’ve focused on residential real estate to stay away from investing in commercial real estate properties. Initially, commercial real estate can be more difficult to get into, and the rules for what makes a successful commercial investment property differ from residential real estate.

Even so, commercial real estate allows for powerhouse investment returns that are difficult to achieve with residential real estate.

Many investors currently investing in residential real estate would like to see a higher return on their investment but are concerned about the amount of money required to finance commercial income properties.

They’ve often heard that commercial lenders require a 30% down payment, which, due to the overall cost of a commercial property, may be more than they can swallow. But, please keep reading.

Different Types Of Commercial Real Estate Properties

Fortunately, there are several ways you can purchase commercial real estate properties with little or no money down.

  • Master Lease AKA Sandwich Lease
  • Contract For Deed
  • Purchase Money Mortgage

We will closely look at these below and examine some of their advantages and disadvantages.

Master Lease AKA Sandwich Lease

Master Lease AKA Sandwich Lease WestwoodNetLease

A master lease is sometimes referred to as a sandwich lease. Sandwich lease works by offering a small amount of money as a down payment to the seller.

While in a standard sale the buyer receives a legal title upon purchase, in the case of a sandwich sale the buyer gets what is termed an equitable lease. The equitable lease gives the buyer a right to fully operate the property as well as allows the buyer to keep all profit accrued above what they pay for the master lease.

You are also entitled to all future equity and any tax benefits that accrue to the property and become responsible for day to day management of the property.

Advantages Of Sandwich Lease

Advantages Of Sandwich Lease

There are many advantages to paying little or no money down. First, the transaction remains between you and the seller, without the involvement of banks, allowing you flexibility when structuring the deal.

Second, a master lease option allows you to test whether or not a particular property will be profitable in the future. You can choose to make any necessary improvements to the property in order to increase NOI. In doing so the increase in value goes to you, the buyer, while the seller receives a monthly payment from you on the interest of the difference between the price agreed in the lease, and what the seller owes. Plus, if you sell the property for more than the purchase price, the profit is still yours.

Besides, the increased equity of the property benefits the buyer when the property is appraised. The increase in cash flow and appreciation raise the appraisal value, which benefits you the buyer if you decide to purchase the property at a later date. You might also decide to wholesale the property to another investor, charging a fee for the investor and making a significant profit.

The best way to find a property where the seller might be amenable to a master lease is to look for income properties owned by an absentee owner, properties that have changed hands due to the death of the owner (and are now owned by family members). These owners are usually quite interested in handing over an underperforming property that, until now, has been a management hassle.

Disadvantages Of Sandwich Lease

If the buyer fails to fulfill the terms of the lease, the seller can foreclose on the property. Or, if the seller does not hold up his end of the lease, a due-on-sale clause on the current mortgage could leave you scrambling for money at the last minute. Also, you need to be careful to perform your due diligence, especially in terms of checking that the title is without liens.

Make sure to hire an attorney to write the master lease agreement: relying on online boilerplate leases could leave you in an unpleasant situation later on.  Also, make sure you have a written backup plan in case things don’t work out as expected, allowing you to end the lease with minimal damages.

Contract For Deed

contract for deed

A contract for deed agreement occurs when you, the buyer, agree to make payments to the seller for the property. In this case the seller is essentially financing the loan, but instead of receiving a legal title, the buyer receives an equitable title. This gives you all the rights and responsibilities of the property.

A contract for deed is a sale, and you receive ownership of the property once it is signed. It is different from a master lease where the lease gives the buyer an option to buy, but until the sale takes place a tenant is essential to sublease the property.

While a contract for deed allows the seller the possibility of a higher down payment and gives the buyer the opportunity to purchase a property without bank financing, there are disadvantages for both sides.

For the seller, an outright sale makes them liable to a transfer tax, and ineligible for a 1031 – which could mean quite a bit of money in taxes. Also, a buyer who defaults becomes much harder to evict than in the master lease scenario.

As a buyer, you’ll need to exercise caution when examining the disclosure report in order to make sure you don’t get stuck with critical repairs that need to be made before the property can be rented out.

It might be best to hire an independent expert to examine the property, since even though sellers may be required by law to provide one, the actual report might be incomplete, out of date, or inaccurate.

Moreover, the price of a contract for deed property is often higher than when the property is purchased through standard means. Plus, some contracts for deeds are structured so that the payment covers interest and only a smart part of the actual cost, leaving the buyer with a high balloon payment in a few years and no way to refinance the deal.

 

Purchase Money Mortgage

purchase money mortgage

Purchase money mortgages are also known as seller financed deals.

In a purchase money mortgage, the seller offers you a loan to purchase the property. So, instead of requiring the standard 30% down, the seller would be willing to accept a promissory note for the down payment; that promissory note is termed a purchase money mortgage.

A purchase money mortgage offers obvious benefits for both the buyer and the seller. In addition to flexible terms and little or no down payment, both are free to negotiate interest rates, payments, or choose a lump payment when the purchase money mortgage ends.

Other sellers like the tax advantage gained by receiving payment over twenty or thirty years, which keeps tax rates much lower than they would otherwise be. The buyer is able to obtain a property with terms that would be unobtainable with a traditional lender. Plus, the seller’s loan can be re-financed just as a standard bank loan can.

Of course, if the buyer misses payments to either the seller or on the mortgage, they risk repossession. The seller must also ensure that the property is maintained well and insured so that it retains its value (in case of a repossession).

Despite the risks, an investor who does a thorough investigation of the property and of its profit potential would still have an excellent chance of making a significant income with little or no money down.

A first or second property purchased in this manner would not only allow you to enjoy the increased profits available to commercial property owners, but it would also serve as a leverage when considering future commercial investment property purchases.

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Tags: cash flow, commercial income properties, commercial real estate, commercial real estate properties, contract for deed, investment property, purchase money mortgage, residential real estate