The Top 10 Mistakes to Avoid When Investing in Commercial Real Estate
Commercial real estate can provide excellent returns if invested in strategically, but there are also many costly pitfalls to steer clear of. As a business owner or investor evaluating commercial properties, be sure to avoid these top 10 mistakes:
- Not conducting thorough due diligence – Never skip the due diligence process which helps uncover issues before you commit. Look deeply into zoning regulations, area demographics, crime rates, schools, local market conditions, comparable rents, tenant mix, operating expenses, leasing terms, environmental factors, flood zones, and overall financials and valuation. For example, neglecting due diligence could mean missing costly zoning changes that limit your remodeling plans.
- Not having a long-term investment strategy – Know exactly why you are acquiring the asset and what your long-term plan looks like. Don’t just chase high yields in the moment, but make choices based on real estate cycles, market changes, and your investor goals for the next decade. Going in without defined objectives will likely lead to poor decisions.
- Buying the wrong location – Location is absolutely key in commercial real estate’s risk and return. Make sure the property has convenient access to transportation, area amenities, a strong surrounding tenant pool and is in an economically stable neighborhood. For instance, properties next to new development could become less appealing over time.
- Overpaying for a property – Don’t overpay based on emotions or “curb appeal.” Know the property’s true value by looking at cap rates for comparable sales within the specific local market and submarket. Overpaying by even a few percentage points can mean massive losses down the road.
- Not thoroughly inspecting the physical property – Look beyond just the superficial cosmetics and dig into the major operating systems like HVAC, electrical, plumbing and the roof as well as the overall structure. Identify any deferred maintenance that may be costly later on. For example, an outdated HVAC system could require a $50,000 replacement soon
- Not evaluating leases correctly – Review lease terms to understand income stability. Look for near-term expirations, tenant improvement allowances, opt-out clauses, and rent bumps.
- Not considering tenant risks – Assess the financial strength of current and potential tenants by looking at sales figures, industry outlook, and credit history. Also evaluate their business operations, foot traffic, and growth plans. Be wary of having too much tenant concentration in one industry or company. For example, having one tenant take up over 30% of the space can be risky.
- Skipping environmental assessments – Always get Phase 1 environmental assessments done to uncover any existing or potential environmental issues that could be dealbreakers. You don’t want to inherit problems like asbestos, contaminated soil or groundwater issues. Catching environmental hazards early allows you to negotiate with the seller or walk away.
- Being underinsured – Make sure you have adequate insurance coverage for the property type and location, while also reviewing amounts for different policy types. Look out for exclusions too. Not having proper liability or flood insurance could lead to massive unexpected costs. Discuss details with an experienced commercial insurance advisor.
- Not building the right team – Surround yourself with an experienced team of commercial real estate professionals like brokers, appraisers, lawyers and accountants. They offer insight and expertise you likely lack, helping avoid missteps. For example, a savvy real estate tax professional can explain the nuances of escrows and 1031 exchanges.
Avoiding these key mistakes will put you on a stronger path to investing in commercial real estate successfully. Be sure to conduct thorough due diligence, create a strategic plan, evaluate all details comprehensively, build the right team, and avoid emotional decisions. This leads to solid returns and meeting your real estate investment goals.
Disclaimer: The information provided in this article is for educational purposes only and should not be considered financial or investment advice. It is always recommended to consult with a qualified financial advisor or investment professional before making any investment decisions.
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