Investing in commercial real estate is risky. If all goes well, you’ll develop a steady stream of income from your tenants and a building that will appreciate over time. But if something goes wrong, the building becomes a money pit that ends up costing you millions of dollars.
To evaluate the benefits of making an investment, start by examining the local market, then the structure and its tenants. Finally, watch for red flags that arise after your purchase.
Understand the local market
When you invest in commercial real estate, understanding what drives demand in that local market, and what risks that market face, is critical. In small markets, knowing what events could radically affect demand in the area improves your ability to make a smart investment.
Dayton, Ohio, offers a great example. Prior to the Great Recession in 2008, the hottest real estate market in the region was the area surrounding Wright Patterson Air Force Base. Defense contractors were gobbling up space at a rapid rate. Congress soon after passed a bill to reduce defense spending, killing the demand and leaving unprepared landlords to scramble for tenants.
The success of a commercial real estate investment often hinges on one number: the amount you paid for the building. If you pay more for a building than it’s worth, you’ll be starting at a disadvantage in your investment, giving other costs for the building much more impact. You won’t be able to offer competitive leases, unexpected capital expenses cause more financial stress and providing the kind of property management that will give tenants the experience they expect can be costly.
How do you discover what a building is worth? The key lies in the valuation, and no two buildings are alike. You have to explore the risks and opportunities. A few questions you should ask:
- What’s the expected rent growth?
- How much time is left on the largest leases?
- How much tenant turnover should be expected?
- What’s the credit quality of the tenants?
If the risks are too high, then you need to walk away from the building or negotiate for a price that is low enough for you to afford to invest heavily in the building.
Watch for red flags
Commercial real estate is not a passive investment. From the minute you sign the deed, you need to pay attention to red flags, including:
- Deteriorating tenant quality
- Late or missing rent payments
- Major losses to the region’s employment base
- Unhappy tenants
If you spot these signs early, begin exploring options to sell before your building loses value.
At Culmen Real Estate Services, we know what it takes to manage a long-term investment to make sure it pays off. We have owned buildings for 40 years, and we know what to look for when evaluating an acquisition. You can trust Culmen to guide you through the many decisions along the way as you manage your long-term real estate investment.