Which is a better deal: the best property in a bad neighborhood, or the worst property in a great neighborhood?
There are numerous factors in deciding whether or not an income property is likely to make a profit… but in the end, location plays a huge role.
A fancy office complex with amazing amenities might seem like a great deal, but if it’s in a declining neighborhood, the vast majority of the time you’ll struggle to find tenants. Even when it comes time to sell, you’ll have a hard time realizing any equity in the property since the location will pull down the overall value.
On the other hand, the worst property in a great neighborhood will almost always offer a way to add value to the property. Even if extensive renovations or a change of usage are required, you can almost always upgrade the property and expect to see results in the form of increased equity or a decrease in vacancies.
There are a few exceptions to this rule, however. Environmental considerations could make renovating a building untenable. Toxic waste in an industrial property, lead paint in an older office or apartment building, or zoning changes can wreak havoc with the best-laid plans. However, these are issues that are easily uncovered during due diligence.
I would add, however, that if a property or neighborhood falls somewhere in the middle, then there might be a lot of leeway in terms of whether or not which is the better deal. A low-priced house in a great neighborhood might still be overpriced due to the neighborhood, and it might be hard to add any value through renovations.
On the other hand, a higher priced property in a Class B neighborhood might be a great investment if the cost is not out of the range of affordability for your typical tenant. So you need to work the numbers for a variety of different scenarios and make sure you do your due diligence.
Is it possible to flip commercial investment properties?
Commercial real estate investors are thoroughly knowledgeable about their field. It’s unlikely you, as a newbie, would:
a) have the knowledge or the experience to answer the numerous, extraordinarily detailed questions that need to be asked just to do due diligence and
b) be able to sell the property at a higher price to a person who already owns 3 or more commercial properties in a variety of niches.
It does happen occasionally that you might be aware of an available commercial property, either because you live in the area, or know the owner well.
In that case, your best bet is to partner with an experienced local CRE broker, in which case, if the deal goes through, you would both get a commission.
Can I buy commercial real estate with no money down?
There are several ways you can purchase a commercial property with no money down.
One, you can do what’s called a master, or “sandwich” lease. That means you purchase the property with little or no money down from the seller. You receive that is termed an “equitable lease,” which gives you full rights to operate the property and allows you to keep any profits that are above and beyond what you pay for the master lease.
In this option, you are essentially a tenant who is (legally) subleasing the property, but who has an option to buy the property.
The second method is through a contract for deed. This is comparable to a lease-to-own in residential real estate, where the owner finances the property instead of a bank. A contract for deeds can be risky, however, since they are often higher in price, and the initial payments may not cover much more than the interest.
Purchase money mortgages are the third way you can buy a commercial property with little or no money down. It is essentially a seller-financed deal where the seller allows the buyer to defer the down payment or parse it out through smaller payments over a long period of time.
I am selling my commercial property and received an offer with “upside participation.” What does that mean?
Upside participation means the buyer feels he can make more money from the property than you are. Most likely he is suggesting a master lease and planning to give you a portion of the presumed additional profits.
Before you consider the deal, however, you should make sure the buyer has a structured plan on exactly how he plans to raise income.
You should also make sure there are clear guidelines on what will happen if he fails to make increase profits, and how long you are willing to wait for that to happen since you will be ultimately responsible for the property until he purchases it outright. Make sure to hire a lawyer experienced in commercial real estate when negotiating your deal.
Can you use leverage in commercial real estate?
You can definitely use leverage in commercial real estate… but the real question you should be asking is how much leverage you should be using.
The high price of the commercial real estate means it won’t be practical or even feasible for investors to purchase a property outright. Therefore a certain amount of leverage is necessary in order to purchase several commercial properties.
Deciding how much to leverage a property will depend on a number of factors, including your risk tolerance, investment goals, interest rates, the profit potential of the property itself, and of course, the lender.
In general, lenders want between 50%-60% loan to value in a property, so even if you want to go higher than that, it is unlikely you’ll find a lender that will finance the property.
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