Commercial Real Estate Investing For Dummies. Peter Harris

are in good hands?

Starbucks is the obvious answer, even though you have higher income on the grocery store. Starbucks is a highly rated company and is publicly traded on the NASDAQ. Its financials are open to the public. It has a responsibility to its shareholders to make a profit. Even if it decides to close up shop there and abandon the property, it must make good on the lease and pay the lease off in its entirety. On the other hand, Grandma’s Corner Groceries is backed by who knows what. Grandpa? If it goes out of business for some reason — fire, theft, infighting, divorce — your options for financial recourse don’t favor your breaking even. So, the property with the Starbucks lease will command a greater value because of its lower risk.

      Here are a handful of things to watch for when reviewing a lease agreement as an investor:

       Rent amount

       Lease term or how long the lease is for

       Additional costs that the landlord and tenant may be responsible for

       Subleasing

       Whether you need to do any improvements to the property before you move tenants in

       Is it a gross lease where the landlord pays expenses or a net lease with the tenant paying their share of the expenses?

      

Read the leases thoroughly many times so that you don’t miss a thing. If you don’t believe us, check out this example about our friends who missed a very important clause in the lease: They purchased a shopping center and the largest tenant, which took up one-third of the total space, had a clause in the lease that said if the store didn’t produce $600,000 in gross sales per year, it could back out of the lease. Two years into the lease, the sales volume dropped below $600,000, and the tenant opted out of the lease.

      Location: The unchangeable factor

As we mention earlier, location is a key factor in understanding what creates value in commercial real estate. How does location create value? One way is job growth. If a city has gone out of its way to attract and entice employers to open up businesses there, that causes economic growth to occur. And economic growth affects real estate value in a positive way, just as a city with negative economic growth causes real estate values to fall.

      SUPPLY AND DEMAND: TIMING THE MARKET JUST RIGHT

      When demand is high for certain commercial real estate, value goes up. Your job as the investor is to find out why. Why is demand high? What’s driving the demand? Is it the influx of companies moving in or expanding in the area? Is it the explosion of retail shopping due to the influx of young families and professionals? Find out what’s going on.

      See where you are in the real estate cycle. Are you in a rising market, at the top of the market, or in a down market? If you’re in a rising market, values will increase. Ride it to the top, and then make a decision to sell or wait for the inevitable downward trend. The downward trend is absolutely okay if the property sustains itself and cash flows well. If you find yourself on the downward trend, get out before you lose too much value or weather the storm and think long term.

      Keep in mind that supply and demand come in cycles. And because of this, property values will be cyclical as well. (Study the real estate cycle in Chapter 2, which will help you see where your market is currently and how values are affected by supply-and-demand situations.) Here’s how you can time the market to ride the wave of increasing value:

       Watch prices. If the downward trend has stopped, you’ve reached bottom or almost bottom. It’s time to buy and ride the wave back up.

       Watch job reports. When job growth is positive, it’s time to ride the wave.

       Watch investors. When you see other investors come in and start investing heavily early, it’s time to jump in with them.

      However, there are pitfalls to valuing the market by watching rising prices, positive job growth, and outside investors. Here are some of those pitfalls:

       You waited too long. Determining exactly when the upward wave starts isn’t easy. If you wait for signs that are too obvious, you can miss the wave entirely. You have to start paddling at some point or you'll have to wave that wave goodbye.

       You misjudged the wave. What you thought was a wave, was just a ripple. Oops.

       You got greedy. People tend to get overly confident when the market just keeps going up and up and up. But what goes up must come down at some point. So, if you wait too long, you may miss your run at the profits.

Certain neighborhoods or districts are better bets than others for commercial real estate, especially if they’re in the path of progress (see Chapter 16 for more on locating the path to progress in your city). New construction and revitalization including changes such as trendy shops or new restaurants are all associated with instilling new life into a neighborhood or district. If you witness an area undergoing any of these, you can bet the real estate values there will be impacted positively.

      

The success of a shopping center, for example, largely depends on its location. You can fix parking lots and physical appearance, but you can’t fix poor location. A great location combined with well-selected stores equals long-term success and a superb investment.

Differentiating a Good Deal from a Bad Deal

      If you get stuck trying to figure out what’s a good deal or how to you define a bad deal, you’re not alone. Unfortunately, the answers can be a bit squishy. After all, what’s good for us may be bad for you, and vice versa. It really depends on the purpose of your investment buys. The purpose behind your investment could be for cash flow, long-term hold, or short-term hold. In this section, we examine all three.

      Cash-flow investors

      Cash-flow investors invest to produce cash-in-your-pocket-every-month income. For the cash-flow investor, any of these would be a good deal:

       A 95 percent to 100 percent occupied, well-maintained apartment complex with excellent professional property management

       An apartment complex that has a breakeven occupancy point of 70 percent or less

       A retail shopping center with a highly rated, credited tenant on a ten-year triple net lease with rent escalations every year

       A multistory office building that you own debt free and that’s filled with great long-term tenants

For the cash-flow investor, any of these would be a bad deal:

       Any type of property with lots of deferred maintenance

       Any property that’s so highly leveraged with debt that if 10 percent of the tenants moved out, you’d be in a negative cash-flow situation

       An apartment complex in an apartment-filled neighborhood in a soft rental market

      Long-term investors

      Long-term investors hold their investments over time and build wealth through appreciation and paying down the loan principal.

      For the long-term investor, here are some good deals:

       A shopping center with a long-term triple net lease in a medium-sized town with an aggressive economy

       An apartment complex built in the path of new construction and