People think that to invest in single-tenant commercial property is the easiest way to enter the CRE market.
One tenant is more easily manageable than multi-tenants, isn’t it?
And to negotiate with one person is more straightforward than dealing with several tenants.
The reality of investing in single-tenant commercial property is not so straight-forward. There are many other variables in the game than just the number of tenants.
If you are an investor, look out for these seven warning signs when considering investing in single-tenant commercial property. Each section will have its own problem, and more importantly, a suggested solution to that problem.
The key factors revolve around the:
- Location of the property
- Tenant’s financial liquidity
- The time frame of the deal
Let’s break those down.
Location, location, location. You’ve heard it hundreds of times.
When it comes to investing in single-tenant commercial property, it could even become a problem.
Let me explain.
1. Inadequate Location Of The Single-Tenant Commercial Property
What has worked for your previous tenant may not work for the next one. If the property has been used by, let’s say McDonald’s and worked effectively for them, the chances of it to work successfully as an office building commercial property is very low.
Also, if you’ve invested previously in a chain restaurant, it may not be the best time to jump into another one. You’ll want to keep an eye on various economic pointers to show you where the money is flowing, so you can invest in a location that will be attractive for a market segment that is growing, and that will grow for at least another 5-10 years.
When choosing a location for your next single-tenant commercial property investment, make sure you are considering factors such as:
- How is this property relevant to my industry?
- Is it easily noticeable for future clients, and their clients?
- How accessible is it for my client’s suppliers and customers?
- Is there an obvious better location at arm’s reach in the neighborhood?
- Is the location on sale because the client base for such a property is diminishing?
This is not an exhaustive list of issues, but it should give you an idea of what issues you should be thinking about.
Another big thing is zoning of the commercial properties. What type of business can operate on a property is related to the type of zoning.
Let me give you a funny example. There are strict regulations on how a commercial property can be used. You can’t just get a property in a family-friendly location and expect to get a casino or an adult entertainment tenant.
Also, you can’t expect to get a cheap industrial property and hope to get a tenant such as a driving school, or a restaurant.
If you are not familiar with the zoning rules, use the knowledge of a Buyer’s Agent. They will make sure you invest in the commercial property that fits your vision of how you’d manage the location.
One of the biggest problems investors face is getting into a CRE purchase without a Buyer’s Agent. You then end up talking and negotiating directly with the Seller’s Agent. The odds are stacked against you as the Seller’s Agent will be well equipped to negotiate from a position of strength, while you’ll be trying to beat a professional in their own game.
This is why Buyer’s Agents exist. You get full professional coverage, at no expense to you. I’ll elaborate a bit more on this “no-expense-for-you” idea later on. For now, let’s get back on track with the potholes you should be avoiding.
The choice of a location automatically leads us to the next warning sign.
2. One-Purpose-Only Commercial Properties
It may be a great idea to buy a NASCAR vehicle. But the thing is, you can’t go shopping with it. It can be a great vehicle, but it’s intended for one thing, and one thing alone.
It is the same with investing in single-tenant commercial property. The inside of the property, the interior, the working schedule, outdoor space or parking space – those are things that are probably designed to perfectly suit the tenant that is currently leasing the place. In this kind of a situation, you’re not positioning yourself properly, and your potential tenant has the upper hand. And you don’t want that.
One-purpose commercial properties could be a good investment under specific circumstances surrounding that industry. But this still exposes you to a risk of having to do some remodeling. It could mean investing more in changing the entire property to meet the needs of other businesses… Or it could mean that you’ll just have to survive the storm of that particular industry and hope for calmer waters soon.
Don’t get me wrong. One-Purpose properties can be great. Say there’s a hospital building on sale, and it’s the ONLY one in a 50-mile radius. It could be a great investment if there’s a new health organization penetrating your target area. But, it could be a terrible asset if there’s another boom town nearby sucking out all such businesses because of better taxation rules.
Again, there are tons of variables in the game, and to make the right decision about the right one-purpose commercial property, you’ll want to use Buyer’s Agents. I mentioned earlier that it’s free of charge. That’s because Buyer’s Agents are actually splitting the commission with the Seller’s Agent. So it’s zero out-of-pocket for you, the buyer.
3. The Physical Condition And Functionality Of The Property
When looking at a commercial property, it’s not only about who is the current tenant and what’s the lease agreement. It’s also about the condition of the property.
- How does the property look like, inside and outside?
- What is a renovation top-priority, if there is such a thing, and who’ll pay the bill?
- What areas are work-related and what areas are additional space, and who owns them?
Single-tenant commercial properties need to meet certain criteria, and if repairs are needed, you’ll want to know who gets to pay the bills.
Buyer’s Agents usually arrange a thorough inspection of the building. At least, that’s how we at Westwood do things. We have pros go in, and make sure we leave no stones unturned. The aim is to find all the faults and all the things that need repairs. Then we get a rough estimate of the cost. This cost is then used in negotiations with the Seller’s Agent.
The aim here is to make sure that we have a clear understanding of all the repairs and all the costs so that we either bring down the price of the property accordingly, or we make sure that the repairs are handled by someone OTHER than you, the buyer.
The benefit of this practice that we’ve been doing for over 17 years now is that at the end of the day, everybody is satisfied with the deal. And the buyer is in fact happy. Because of this commercial real estate due diligence, even Seller’s Agents love working with Westwood. They know that we cover all the bases, and a Letter of Intent with a Westwood logo is as good as a closed deal.
4. Credit-Worthiness Of The Tenant
By this point, the location and the background check on the property are done. The next step should be to run a similar tenant due diligence. There are in fact businesses focused on doing only tenant screening. While this could be a good practice, it doesn’t have to be the case if you rely on a detail-oriented Buyer’s Agent.
But how can one tenant assure you that their business will be successful enough for them to be able to pay the rent in the next 5, 10, 15 years?
Single-tenant commercial property investing is by default, a long-term relationship.
They last longer than the usual commercial properties. Usually, in a Triple Net Lease situation, you’re delegating all maintenance responsibility to your tenant. This leaves you, the landlord, with practically no financial responsibilities of owning the property. Other than collecting rent, of course.
It’s essential for any investor to check the financial stability of the tenant and insert clauses in the contract that will protect you, the investor. An NNN Lease will usually take care of this, but still, you will want an experienced advisor to work with you and protect you from entering a potentially not-so-good of an investment.
Hiring a capable Buyer’s Agent will make the tenant due diligence process much easier for you. Actually, with Westwood, you don’t get to bother with doing any due diligence. That’s our part of the job. We’ve had many cases where the investor has two or three properties in mind, and after doing the needed tenant due diligence, we help the investor pick the one that’s most profitable on the long run.
That way, we protect investors from entering sour situations, which saves you tens of thousands of dollars, and tons of frustrations.
5. The Danger Of Vacating The Single-Tenant Commercial Property
Checking the creditworthiness of the tenant is in many ways connected with the possibility of them vacating the property. Single-tenant commercial properties sometimes are perceived as safe, predictable passive income. But in too many cases we’ve seen that it’s not as safe or predictable as people will want to believe.
Business prosperity is not a right of every business owner. It’s a result of lots and lots of variables. Some people get it right and prosper. Some… Close shop and get a job. And when businesses close, landlords lose a client. Our aim here is to help you pick a property that will attract a business that is stable for at least 10 years.
The thing with the single-tenant commercial properties is that once your tenant leaves, you are without that income. This is why you want to know the tenant, know their industry, and know many economic and demographic pointers of the area you’re eyeballing.
A single-tenant commercial property is either totally in use or not at all. As an investor, you need to have this factor in mind, to better protect yourself from investing in property that will crumble in a year or two.
Buyer’s Agents who are good at their job will make sure you get properly advised. We at Westwood make sure to help you see the wider picture surrounding each property that you have selected. We also do the same contextual overview of any properties that we recommend.
The goal here is to help you realize that, while you are investing only in a commercial property, the reality is that you are in fact stepping into several industries where your tenants make their living.
When you work with a Westwood Buyer’s Agent, you get advice on which property has better-earning potential, and which property will be better equipped to provide you with a solid exit strategy, 10, 20 years down the road.
6. Big Franchise Mistake
A famous business name on the single-tenant commercial property doesn’t always guarantee success. If you see the name of a famous, successful brand on a property that is on sale, please don’t assume anything.
Let me elaborate this in more detail.
Say you’re driving by and you notice a McDonald’s building on sale. You call the number, and the price sounds just right for the location and size of the building you’re getting. Sounds like a keeper, right?
Well… Let’s take a step back. McDonald’s owns most of their buildings. Some 70% of all McDonald’s locations are in fact in full ownership of the company. So if a company is selling a property, you’ll want to know WHY they’re jumping ship here:
- Is it because they’ve appreciated the property enough so they cash out?
- Is foot traffic lower than expected, and not enough to maintain a profitable presence?
- Is drive-through traffic decreasing because of a new street, or a new competitor?
- Is the building too expensive to maintain and keep it up to spec?
Big brands have big pockets and large teams that do number-crunching all day long. If they decide to cash out, it doesn’t mean… well, it doesn’t mean anything until you do your homework and figure out what’s going on.
This is again, why smart commercial real estate investors rely on Westwood. We know how to quickly and effectively contextualize each deal, and give you a good explanation of why it is a great deal, or why it’s a terrible deal.
There’s more to a property than the price, cashflow, building size and so on. With CRE, you’re playing with (and against) big players, and you’ll want a team that has your back.
7. Lease Time-Frame
Investors choose to invest in single-tenant commercial properties because it’s usually a triple net lease deal, and it usually lasts for 10 to 15 years.
But if the owner is ready to sell, will the tenant be ready to stay?
At first glance, the property may be perfectly suited for you. It may be on the right spot, with the right size, in the right price range. But for your investment to be profitable, time is of the essence.
And the key question will be is the tenant willing to stick around. Their current lease may not be locking the tenant in the property for enough time. So you may want to speak to the tenant before you do any signing of documents.
We’ve seen that tenants will be willing even to sign a lease with the new landlord if you do the talking and negotiation properly. And as you already know, negotiation is an artful skill that pays for itself.
Westwood Buyer’s Agents have helped transition tenants into a new ownership situation seamlessly and made many deals go by without any turbulences for all parties involved. Again, this is why so many Seller’s Agents love working with Westwood. We make sure that the people involved in the deal are all on the same page, and they’re all satisfied with the new deal.
Let’s Wrap Things Up
These 7 potholes of single-tenant commercial property investment are just a handful of warning signs you need to keep an eye during any CRE investment.
You’ll need to have good answers to questions like:
- Who’s selling
- Why are they selling
- Who’s the tenant
- Can they stick around for long enough
- Will the transition go smoothly
In order for your next purchase to be profitable in terms of cash flow, and with a smooth exit strategy, you’ll want to cover all these questions, and then some.
Westwood is here to help.
So if you already have a property in mind, or you’re looking for a property and need help with a shortlist, or you’re in a time-crunch to do a 1031 Exchange, don’t hesitate to give us a call.
We’d love to help you out.