An Introduction to the Commercial Real Estate Business

Dealing with commercial real estate is very different than working with residential real estate. With residential real estate you deal with single family homes, duplexes and small apartments. With commercial real estate you will be dealing with office buildings, retail stores, warehouses, and more. Here are a few basics involving commercial real estate.

Value

One of the most important things in any area of real estate is the value of the property that you are dealing with. The way that you value residential property is drastically different from commercial property. When dealing with residential property, you will come up with value by comparing the property to other similar properties. You will gather recent comparable sales and arrive at a value. With commercial real estate, you do not always compare the property to other similar structures. Instead you compare it by how much income it brings in for the owner. The income approach to evaluating property is the most common approach with commercial real estate.

Cap Rate

One of the most common terms thrown around in commercial real estate is the cap rate. Cap rate is short for capitalization rate. This is a figure that helps represent the value of the property and the income that it produces. To get the cap rate of a property that is for sale, you will take net operating income of the property and divide it by the asking price. For example if you had a net operating income of $200,000 and an asking price of $2,000,000 your capitalization rate would be 10%. This is how you can quickly determine the value of a property and see if the asking price is in line.

Agents

The selling process of commercial real estate is also much different than residential real estate. Commercial real estate agents work in a different environment than their residential counterparts. The commercial real estate environment is very professional in nature. Commercial real estate brokers have to deal with CEO's and prominent business people on a regular basis. The commissions in a commercial real estate transaction are much larger than they are with residential sales. Sometimes, a large piece of property can take several years to sell. Therefore, commercial real estate brokers are not regularly paid.

Seller Financing

With commercial real estate, the financing works a little bit differently than when you buy a house. For one thing, seller financing is commonly used. This type of financing is usually very short-term in nature. The seller might offer two years of seller financing in order for the buyer to develop a history of income with the property. Then they can secure traditional financing from the bank and pay off the seller. Therefore, the transaction process can take many months or years to completely go through. If you are trying to sell a piece of commercial real estate, you will have to be open to many options.



How can you invest in commercial real estate?



If you want to invest in commercial real estate, there are a few different ways that you could do so. One way that you could start investing now is to purchase shares of an REIT. This is a type of trust that you can purchase shares of as if you were buying stock. These entities invest in real estate and share the profits with investors. You could also enter into a partnership with other individuals who want to get involved with commercial real estate. This will allow you to combine your funds together and purchase a piece of commercial real estate.



How to Finance Commercial Real Estate



To finance commercial real estate, you will have to be able to meet a number of criteria. You have a few different options when it comes to coming up with the money that you need to purchase commercial real estate. Choosing the right option and then following through is critical if you want to get involved in this industry. 

Down Payment

If you want to get a loan for a piece of commercial real estate, you should come up with a substantial down payment. Commercial property lenders like to work with individuals that have a large amount of cash for a down payment. Since commercial real estate is risky, they like to see that you are willing to risk some of your own money in the deal. With commercial real estate, it is common for the lender to ask for a 30 percent down payment or more. 

Collateral

If you are going to try to finance the property by yourself, you will most likely have to come up with some type of collateral for the bank. This could be any number of items as long as they are of sufficient value. You may need to put up your private residence as collateral. You might also be able to use securities that you own as collateral for the loan. The lender likes to know that they will be able to foreclose on something of value if you are not able to make payments. In many cases, they will prefer property that can easily be converted into cash so that the foreclosure process is easy to complete in the event that it is necessary.

Balloon Loans

When you are trying to get financed for a commercial real estate loan, you might also need to look at balloon loans. Balloon loans are commonly used for commercial real estate. With this type of loan, you will be making interest-only payments during the life of the loan. Then when the loan is finished, you will have to make a balloon payment for the entire amount that you originally borrowed. This type of loan can be risky because you have to refinance the loan or come up with the money through some other means. At the same time, it can make your payment more affordable. 

Partners

Many people also use partnerships to finance commercial real estate. You can set up a partnership in which you are the general partner and you take on limited partners. The limited partners could provide funds for the purchase of the real estate, but as the general partner, you would make all the decisions for the business. You also handle the management of the property while you are in possession of it. Many wealthy investors like to find deals like this, as they allow them to earn a return on their investment without having to deal with the problems that come with property management.

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