5 Sure-Fire Ways To Get Crushed In A Commercial Deal
What the broker package makes the property sound like:
What the property actually looks like upon arrival:
Let’s face it – not all commercial properties are cherry and not all commercial brokers or sellers are above board when it comes to disclosure. The commercial world is truly one of caveat emptor, or let the buyer beware. And because it’s not a consumer transaction, you won’t get much help from government regulatory officials if you get ripped off.
For this reason, it is imperative you conduct proper due diligence to understand where the major cracks can occur in the foundation of a commercial deal. Although this is no replacement for experience, proper education, a commercial lawyer, or a mentor, here are the 5 biggest ways you can start down the road of financial independence and end up on the streets of financial heartbreak:
1) You don’t know the real value – Different types of commercial properties use different valuation models and have different cash flow expectations. If you don’t know the “real” formula to use to value a particular type of income property, but rather rely on the seller or broker’s number, you could find yourself overpaying for the property.
2) You don’t understand financing – Although liquidity for commercial deals is out there, it is still tight. Currently, conventional financing is only available for performing properties. What does that mean? It means, for example, in an apartment building deal the building must be 90% or more occupied for at least 1-2 years. If you don’t have that, you will have trouble getting a lending commitment or you will have to infuse more cash into the deal.
3) You invest in bad areas – Section 8 financing sounds great because it’s “guaranteed,” but what happens when high crime chases even all those tenants away? High crime areas inevitably lead to high vacancy. You won’t be able to overcome high crime and high vacancy without turning around the entire neighborhood, so don’t let the high cap rate lure you in. There are enough good deals out there in good areas that you don’t need to be visiting your properties in a bullet-proof vest.
4) You get fooled by “pro-forma” numbers that are provided by a broker or owner – Surprise, surprise! Sellers and brokers like to give you “fantasy” numbers based upon sometimes unrealistic occupancy rates or rent numbers that aren’t in line with the current economic conditions. Sure your property will produce at a 23% cap rate – but only in 15 years and only if David Hasselhoff becomes President or stops eating hamburgers off the floor. Never, never, never, rely on the seller or the seller’s broker for numbers. There is no substitute for independent, third party evaluations.
5) You fail to conduct proper due diligence – I know this is somewhat a repeat of #4, but that should highlight for you how important it is to conduct proper due diligence. Inspections of the property. Environmentals. Audit of the books. Back-up bank statements. Affidavits of existing inventory. All the things a good mentor and commercial attorney can help you with. Your due diligence file should be HUGE.
6) You don’t have good management in place (In know…Good pickup. I only said I was giving you 5 tips. I started writing and couldn’t stop. Consider this your Bonus Tip – for FREE!!). I know investors that buy multi-unit buildings and are highly leveraged. In the first several years, when stabilization may be a problem, it is easy to get into problems if you have either an incompetent or dishonest management company. You have to conduct due diligence not only on the property, but also on the management company. And you MUST have someone locally that can check on the property periodically to ensure the management company is performing. Bad management equals high vacancy rates and lost money, so be careful!
Look for some commercial videos soon!
Need to understand commercial lingo, what the hottest commercial opportunities are right now, or how to start in commercial investing? I’m getting a commercial property author, investor and expert to give away some training videos for free to our subscribers to help you get started.
I’ve also got some good webinar stuff lined up on commercial investing so, if you want to take the next step, you can.
Stay tuned! Til’ next time, Jeff