5 Vital Steps to Take Before Buying Commercial Property

So you have seen a commercial property you like and you are eager to sign on the dotted line and make it your own. But have you done a commercial property appraisal to ensure that its price is not inflated? Or have you verified the title to the property or whether it conforms to zoning regulations?

Yes, the feeling of exhilaration is understandable. But there are vital steps to take before signing on the dotted line. We review five of them below:

Conduct due diligence

A due diligence process is one where you assess the risks and opportunities associated with a given property. It typically includes taking these steps:

Verifying ownership: You want to ensure that the person claiming ownership of the property has a legal right to it. The property’s documents should be verified with the relevant agencies.
Physical inspection: This involves checking the property’s structural integrity and compliance with safety regulations. You want to ensure that everything is as advertised.
Legal and zoning checks: You also want to ensure that the property is free from encumbrances and is not in violation of any zoning regulations.
Environmental regulation checks: You also want to ensure that the property is not in violation of any other environmental regulations.
Verifying financial records: If the owner claims that the property is making a certain amount as net operating income per year, ask for verifiable documents to confirm the claim.

Do a property appraisal

The only way to ensure you are consistently profitable as a CRE investor is to avoid buying properties for more than they are worth. When you overpay for a property, your return on investment falls, except you can also get others to overpay for it when you are selling.

This is why it is advisable to have a maximum offer in mind before buying a property.

Conducting a property appraisal will help you determine its fair price and this will guide you when deciding your maximum offer.

There are four ways to execute a commercial property appraisal:

Income capitalization approach: In this approach, the property’s fair value is its net operating income (NOI) divided by your desired cap rate. If NOI is $100,000, for example, and your desired cap rate is 8%, then the property’s fair value is $1,250,000.
Sales comparison approach: A property’s fair value is equal to the average market value of comparable properties (similar features, same location, same property type, similar size, same zoning regulations, and similar age, among others).
Cost approach: This approach values a property based on the costs of constructing it anew minus accumulated depreciation since it was constructed plus the fair value of the land.
Gross rent multiplier approach: The gross rent multiplier (GRM) is the property’s value divided by its gross yearly rent. If you know the average GRM in that location, you can work backwards to determine the property’s value based on its gross yearly rent. For example, if the average GRM is 10 and the yearly rent is $100,000, then the property’s value is $1,000,000 (GRM * gross rent).

Negotiate price and terms

If the price on offer is above the fair price you have calculated, then you should try and negotiate for a lower price. As said above, when you pay too much, you bring down your ROI or you may have to wait longer than usual before you can sell the property at a price that will sustain your desired ROI.

You should also negotiate the contingencies that will be included in the deal, the closing costs, the due diligence period, and the earnest money deposit required, among other details. To survive in this business, your negotiation skills have to be top-notch.

Conduct market research

Buying the property at its fair value is one thing, collecting the rent that justifies that fair value is another thing. For example, if you paid $1,000,000 for a property and the GRM is 10, then you are expecting a gross yearly rent of $100,000. Is that feasible?

This is where market research comes in. It’s possible that the former owner was able to collect that amount in rent but that does not guarantee future payments. Changes in demographics, economic situations, and security conditions can reduce demand and make your desired rent untenable.

In other words, before signing the dotted line, ensure that you have conducted enough market research to be sure that projected changes will not hurt your investment.

Secure financing

You will also need to secure financing before you can buy commercial property of your choice.

First, you will need to pay an earnest money deposit (EMD) and then the purchase price (plus closing costs).

With a company like Duckfund, you can secure earnest money deposit financing at the beginning of the deal. You can complete an application in two minutes and the required funds will be transferred to an escrow within 48 hours.

But paying EMD is just the beginning. Knowing how to buy commercial property also involves securing finance for the purchase price. Duckfund also helps at this latter stage. They offer equity financing (up to $100 million) and debt financing (up to $500 million) for all types of commercial properties.

Following these five steps will help you become more profitable as a commercial property investor.