Commercial real estate can be a great investment. You buy a building, lease it to a company, and get a rent check in the mail each month.
So how do you determine whether a particular piece of real estate is a good investment? There are several main factors: location, return on investment (ROI), appearance, and a clear title.
But first, what exactly is commercial real estate?
What Is Commercial Real Estate?
Commercial real estate is any piece of land that is zoned as a business. This would be the land used by restaurants, shopping centers, hair salons, almost anything besides houses and apartments which are residential and properties owned by the government.
This is arguably the most important factor. You can fix a building with an ugly appearance, but unless you’re the Hulk, you can’t pick up a plot of land and hurl it into a better location.
A good location is one with a lot of foot traffic because foot traffic generates sales. Thus a property in one part of town can cost several times more than an identical property a couple miles away. A good location will attract businesses who will be willing to pay you a higher rent.
A restaurant in a busy part of town has a better location than one in the middle of nowhere, and a store by the road has a better location than one a ways off and hidden from view.
ROI tells you how much money you can expect to make for your investment. You calculate it by dividing the annual rent income by the cost of the property.
For example, if a plot of land costs $1,000,000 and you expect to make $100,000 every year from your tenants, then you divide 100,000 by 1,000,000 to get 0.1 or 10%. This means that every year you’ll make 10% of what you spent.
ROI varies a lot, but it’s typically between 10-20%. In some circumstances,10% or lower may be a bad investment.
No one wants to shop at an old, run-down store. Before buying a property, ask yourself if it looks new and clean, if it looks like somewhere you’d want to go. Just remember: location trumps appearance. You can always upgrade a building to look new, although it may cost a lot.
Clear and Cloudy Titles
A title is the deed of ownership for a building. When you purchase a property, you should also buy title insurance. When you do, the title company will perform a title search where they search through the records of everyone who has owned that piece of land over a period of time.
If everything looks normal on the title search then the title is clear. If the title company finds something fishy, it’s called a cloud on title. An example of this would be if a couple owned the plot 20 years ago and the husband signed to sell but the wife didn’t, yet somehow the land got sold anyway. In such a situation, the wife could return and claim she still owned the land.
Avoid buying property with a cloud on the title. Also, visit our title fee calculator for Tennessee.
If you invest in commercial real estate, one thing you’ll want to decide is whether you’ll rent to one tenant or multiple tenants. For instance, sometimes owners will buy a large building and rent it to several stores or restaurants.
If you have multiple tenants, you’ll probably include common area maintenance in your contract. This term means that you, as the owner, are responsible for keeping the communal areas (sidewalks, parking lots) clean. In most contracts, the owner will then bill each tenant for the cost of the cleaning.
Many leases are called Triple Net Leases. This means that the tenant will reimburse the owner for insurance, property taxes, and maintenance. This is usually done pro rata meaning that each tenant pays a portion equal to the percent of the building they use. For instance, if one tenant uses 30% of the building, they will pay 30% of insurance, property taxes, and maintenance.
If you’re buying a property, you’ll need a commercial real estate attorney to help you draft a fair contract. Our lawyers have represented clients for over 20 years. Let us serve you.