Three BIG mistakes Commercial Real Estate Investors Make
As a commercial real estate investor, you either occupy (with your business) the commercial real estate you own, you don’t occupy (with your business) the commercial real estate you own, or you do both.
Today, I want to discuss the three BIGGEST mistakes that I have witnessed with investors that DON’T occupy the commercial real estate that they own.
They over leverage.
Leverage is defined as the ratio of debt to equity. If your commercial real estate is leased and the tenant is paying a sufficient rent to exceed the monthly mortgage payments, also known as “debt service”, the amount of debt vs. equity (leverage) is secondary. However, if the tenant vacates, the amount of leverage becomes a BIG deal! In order for you to receive a positive cash flow, you must find a new tenant that will pay rent in excess of your debt service. The more debt you have in relation to your equity, the higher the debt service becomes. With higher debt service, the resultant rent must be higher or you are forced to subsidize the difference. I have seen many investors who lease their building at the current market rates, incur debt based upon the rent amount, and then the tenant vacates unexpectedly. The investor is left with a building with no income and a huge payment…a formula for disaster! An investor should ALWAYS have a feel for the current market rents and how these market rents relate to the debt service he is paying. Regardless of what the current tenant is paying, if your debt service exceeds the current market rent, you are well advised to refinance or make some debt service reserves in case your tenant should vacate before his lease expiration.
They don’t properly budget for turnover.
Turnover is the loss of one tenant and the move-in of another tenant. The time between your current tenant vacating and your new tenant occupying is frequently underestimated by many investors. Additionally, your new tenant may require some free rent, some alterations to the existing office layout, or some refurbishment of the building. ALL of these items are expensive, so make sure you properly budget for them. A reserve account of one years rent is not excessive.
They try to time the market.
Commercial real estate ownership is either a VERY short term play or a VERY long term hold. Investors who attempt to “time the market” frequently miss the mark and pay too much for their real estate or miscalculate their ability to exit the market. Decide, before you purchase commercial real estate, whether you intend to buy it, fix it, lease it and sell it quickly or whether you plan to pass the commercial real estate on to your grandchildren.
Photo Credit: “No Sign” by digitalart Source: freedigitalphotos.net