Types of Multifamily Financing: Rates, Terms & Qualifications

Multifamily financing is a mortgage used for the purchase or refinancing of smaller multifamily properties that have two to four units and large apartment buildings that have five or more units. Multifamily loans are a good tool for both first-time real estate investors and seasoned professionals. Rates are generally between 4.5 percent and 12 percent with terms up to 35 years.

If you’re looking for a permanent multifamily loan for rental units you can check out Visio Lending. They’re a national lender that can finance 2 – 4-unit buildings up to 80% LTV. Terms are 30 years with fixed or variable competitive rates. Apply online today and get pre-qualified in a few minutes.

4 Types of Multifamily Loans

Type of Multifamily Loans

Conventional Multifamily Mortgage

Investor who wants to purchase a 2-4-unit building in good condition and may already have a banking relationship with a traditional lender

Government Backed Multifamily Mortgage

Owner-occupant of a 2-4-unit property or large investor who wants to use an FHA multifamily loan to purchase a 5+ unit building

Portfolio Multifamily Loan

An investor who doesn’t meet the qualifications of a conventional mortgage or an investor who wants to finance multiple properties at once

Short Term Multifamily Loan

A fix-and-flip investor who wants to purchase a distressed property quickly

1. Conventional Mortgage for Multifamily Properties

Conventional mortgages for buying a multifamily home are permanent “conforming” loans offered by traditional banks and lending institutions. These mortgages have terms of 15 to 30 years and can finance multifamily properties between two and four units but can’t finance apartment buildings with five or more units. Conventional mortgages are conforming because they typically adhere to Fannie Mae’s required qualifications and maximum loan amounts. However, they aren’t backed by the federal government.

Conventional mortgages for multifamily homes are right for investors who want a long loan term. They’re right for investors who purchase a multifamily property that has already been rehabbed. They’re also right for investors who already have a banking relationship with a financial institution that offers multifamily loans.

The rates found on a conventional mortgage can be either fixed or variable. Fixed rates are fully amortized throughout the loan’s term while variable rates typically reset after a seven- to 10-year period. Variable interest rates are based on the six-month stated Intercontinental Exchange London

Where to Find a Conventional Mortgage for Multifamily Properties

You can use Winston Rowe and Associates to connect with multiple lenders and receive multiple offers at once. They can help you find the best rates, terms and fees on your conventional mortgage quickly.

2. Government-backed Multifamily Financing

Government-backed multifamily financing is multifamily loans sponsored by Fannie Mae and Freddie Mac as well as the Federal Housing Administration (FHA). There are more than five government-backed multifamily financing options, which can either finance properties with two to four units or properties with five or more units.

Government-backed multifamily loans are right for investors who want to live in one of the units and rent out the other units. Investors who only have a small down payment can also benefit from government-backed multifamily loans. They’re also right for larger investors who want to purchase a five or more-unit property with an FHA multifamily loan.

Fannie Mae and Freddie Mac also have multifamily financing loans that can finance properties with five or more units. These government-backed loans are often referred to as “small balance loans” or “multifamily loans.”

Both Fannie Mae and Freddie Mac multifamily loans have terms between five and 35 years. The time to approval and funding with these multifamily loans can be 60 to 90 days. For FHA-backed multifamily loans, the term can be as long as 35 years. Because there are more regulations and guidelines with FHA loans, the time to approval and funding is longer at 60 to 180 days.

Fannie Mae and Freddie Mac’s multifamily financing options together can fund the purchase of a multifamily property between two and five units or more. Just remember that the conforming loans can finance properties between two and four units while the nonconforming multifamily loans can finance properties of five or more units.

The Fannie Mae, Freddie Mac and FHA multifamily financing options are originated and offered by government-approved mortgage lenders. For example, the Commercial Real Estate Finance Company of America offers all government-backed multifamily loan options.

3. Portfolio Loan for Multifamily Properties

A portfolio loan for multifamily properties is a nonconforming loan used to purchase a multifamily property between two and five or more units. Portfolio loans for multifamily properties are permanent mortgages with terms between three and 30 years.

These types of multifamily loans are right for investors who need more flexible multifamily loan requirements. They’re also right for investors who want to finance multiple properties at once because they can finance four to 10 properties simultaneously.

Where to Find Portfolio Loans for Multifamily Financing

Remember that since portfolio loans are nonconforming loans, they’re offered by lenders of all shapes and sizes. Traditional banks, credit unions and savings and loans, as well as private lenders, can all offer portfolio loans.

Winston Rowe and Associates capital sources offer multifamily portfolio loans for rental properties with two to four units. The national lender can finance up to 80 percent LTV. Terms are 30 years with fixed or variable rates that are competitive. Apply online and pre-qualify in minutes.

4. Short-term Multifamily Financing

Short-term multifamily financing is a non-permanent multifamily loan option with terms that range from six to 36 months. These loans include both hard money loans and bridge loans with monthly payments that are usually interest-only.

Short-term multifamily financing loans are right for investors that want to season, renovate or increase the occupancy a multifamily property in order to meet the stricter requirements of a permanent multifamily loan. Furthermore, some investors use these non-permanent options to buy a property and wait until they meet the personal qualifications before refinancing.

The LTV ratio is based on a multifamily property’s current fair market value and is used to finance properties in good condition. The loan-to-cost (LTC) ratio, on the other hand, is based on the combined costs of purchasing and renovating a multifamily property and is used for properties in poor condition. This means that an investor should expect to cover 10 percent or more of a property’s purchase price or 25 percent or more of a property’s purchase price plus renovation costs.

Permanent Multifamily Financing Options

Permanent multifamily mortgages have repayment terms of five to 35 years and have a loan-to-value ratio (LTV) of up to 87 percent. Interest rates range between 4 percent to 6 percent and rates can be fixed or variable. Permanent multifamily mortgages are the most common type of multifamily financing and account for 93 percent of outstanding multifamily loans.

Although permanent loans are generally long term, there are some shorter options. For example, government agencies offer loans that have terms between five to 10 years.

These multi-family loans are right for:

Investors who intend to pay off a multifamily loan within 10 years

Investors who need lower payments at the start of the loan

Investors who want an adjustable rate loan

Investors who want to renovate a multifamily property during a five to 10-year period

On the other hand, long-term permanent multifamily loans have terms between 10 to 35 years. Monthly payments are typically amortized during the entire term. What’s more, interest rates are typically fixed.

Long-term permanent multifamily financing options are right for the following investors:

Investors looking to purchase a long-term multifamily property

Investors looking to refinance an existing multifamily property

Investors looking to cash out refinance an existing multifamily property

Temporary Multifamily Financing Options

Temporary (short-term) multifamily loans, such as hard money loans, are mortgages with terms between six and 36 months. Monthly payments are typically interest-only with fixed rates between 4 percent to 12 percent or more. Temporary multifamily financing options are used to purchase, renovate, season or sell a multifamily property before refinancing to a permanent mortgage at a later date.

Theses temporary multifamily loans are right for:

Investors who need to season a multifamily property

Investors who need to increase the occupancy rate of a multifamily property

Investors who may want to renovate a multifamily property

Investors who don’t meet the stricter qualifications of a permanent multifamily loan

Investors who need to compete with all-cash buyers

Overall, investors of multifamily properties should be willing to be active in the management of the property. They should have at least nine months cash reserves not only to cover monthly loan payments through vacancy periods but also to cover unforeseen repairs as needed.

What Qualifies as a Multifamily Home?

A multifamily property is generally a residential property with two to four separate units. This is how lenders define a multifamily property. However, the FHA considers a multifamily property one that has five or more units.

Multifamily loans are used by investors to finance multifamily properties between two and five or more units. These properties can include condos, town homes, duplexes, apartment buildings and more. However, there are many different multifamily financing options available and it’s important to understand the best ways to invest in real estate.

What are Construction Loans and how do They Work

Commercial Construction Loans

A construction loan is a type of bank-issued short-term financing, created for the specific purpose of financing a new home or other real estate project.

The loan can be applied for by anyone who is investing their time and money in construction or related expenses. An individual homeowner, a contractor, or a small business owner can use construction loans to finance their construction project.

Not just for the actual building, a construction loan can also be used to pay for building equipment used in construction, building materials, or for hiring employees.

Here are some uses and things to know about construction loans:

New construction:

If you are an individual or small business owner who is looking for funding to build a new home for yourself or a client, then you can apply for a short-term construction loan. This type of loan can be used to pay for the construction of new buildings. Construction loans have high-interest rates owing to the risk involved.

Builders or homeowners who want to build custom homes generally look to a construction loan. After completing the project, you can refinance the loan into a mortgage, or you can repay it by taking a new loan from another financial institution.

Expect a big down payment:

Construction loans generally require a large down payment of around 20-25% of the total cost of the project, usually the cost of construction and mortgage.

Thorough application process: When you apply for a construction loan, you’ll be asked to provide the details of your construction project, including like the total amount of funding required, details about the builder, a detailed project timeline, the floorplans or construction drawings, the cost of materials, and the cost of labor.

Look out for paperwork:

Until recently, it was hard to find lenders offering construction loans online. If you know you want to apply for a construction loan, you might find it easiest to visit your local bank or regional credit unions and ask for information in person.

These institutes will be aware of the local property and construction market, and should be able to help you create a plan for your application.

Types of Construction Loans:

Construction Mortgage Loans:

This is a loan you can use to finance the purchase of land, or construction of a home on land you already own. These loans are usually structured so that the lender pays a percentage of the completion costs and you, the builder or developer, pay the rest.

During construction, the lender will release your funds in a series of payments, called “draws.” Typically, the lender will require an inspection between draws to check that the project is proceeding as planned.

As the borrower, you are responsible for paying interest on the amount of funds you use. This is different from a term loan, where you get a lump sum payment at once, and then pay back interest on the whole amount. Once your construction is complete and your interest paid, you’re responsible for repaying the entire loan amount by the due date.

Generally, construction loans have short terms because they reflect the amount of time it would take to build the project; a year-long term is common.

Construction-to-Permanent Loans:

Also called the CPloan, construction-to-permanent loans are another option for financing the building of a new home. CPloans offer some extra convenience to borrowers by combining two types of loans in a single process.

During construction, if you have a construction-to-permanent loan, you only pay interest on the outstanding balance, at an adjustable rate determined by the lender and pegged to the prime rate. The prime rate is a widely-used benchmark based on the federal funds rate, which is set by the Federal Reserve, meaning that if the Fed raises rates, then the interest rate on your construction-to-permanent loan will rise, too.

When the construction phase is over, the C2P loan converts into a standard 15- or 30-year mortgage where you pay principal and interest.

The advantage of construction-to-permanent loans for small business owners and homeowners is that instead of having to get a loan for the construction phase and then a second for financing the finished project, you get two loans at once. In this scenario, you only close once and pay one set of closing costs.

Commercial Construction Loans:

If you’re thinking bigger and planning to construct a multi-family home or apartment building, high-rise, multi-unit retail center, commercial office building, or other type of larger project, then you should probably be looking for a commercial construction loan.

Lenders for modern commercial construction loans for apartments and similar big projects are extremely risk-avoidant, and will expect a developer to shoulder most of the risk by covering up to 90% of the cost of the project. If you’re involved with this type of commercial project, you’ll need to be prepared with a lot of cash on hand to fund the construction yourself.

What are the Reasons for Getting a Construction Loan?

Purchase Equipment and Materials:

You can use a construction loan to buy material and equipment that will be used in the construction of the new home.

Expanding a Company’s Facility:

If you are a small business owner with a physical location and you need to build a new office or remodel an existing one, then you can use construction loans to finance your construction project.

Hiring and Training Employees:

You can use the funds from a construction loan to hire new employees for construction purposes. You can also finance education and training costs for those employees with your construction loan.

Overcoming Damage or Disaster Expenses:

If your office or commercial property is damaged by unforeseen circumstances like an earthquake or other disaster, you can use construction loans to make necessary repairs.

How Can You to Qualify for a Construction Loan?

Most lenders consider construction loans risky, so you’ll face some stiff requirements if you decide to apply.

Here are things lenders require

Down payment:

To get a construction loan, you’ll need to make a down payment of 20% or more of the cost of the total project. This means that you will need to be prepared to start the project with your own funds or assets before a lender will agree to loan more. If you already own the land, for example, it’s likely that you will be able to use that toward the down payment amount.

Talk to your lender about this. The particular amount of your down payment will depend on the cost of your project, the land, and what you plan to do with the funds. Lenders require high down payments as a way of making sure you’re invested in the project and won’t vanish if things go wrong during construction.

Strong personal credit:

Anytime you apply for a construction loan, you’ll need to provide the lender with your personal credit history–even if you are applying as a small business. The lender will almost definitely want to see your personal FICO score and your business credit history, too.

Financial documents:

Typically, a prospective lender will analyze your current and past debt and payment history, as well as any other loans or liens you may have on your property. Whether this loan is for your own home, or for a small business construction project, you’ll be asked to provide financial statements, tax returns, and proof of other assets.

Good reputation:

Whether you are the builder, or you are working with a builder, know that the lender will scrutinize the builder’s reputation. Any public information is fair game for making this judgement call: vendor and subcontractor reviews, online reviews, and previous work history.

If you are working with a builder, they should not hesitate to provide evidence of their good reputation, along with the detailed project plans and cost estimates you’ll also need.

If you need help finding a qualified builder, check out one of the many National Association of Home Builders chapters closest to you. A trusted local builder with a solid history of successfully completed projects will have an easier time getting a vote of approval from a financial institution in the form of a construction loan.

Specific plans:

To qualify for a construction loan, you must have specific and detailed building plans, construction contracts, and cost estimates ready.

Appraisal:

It’s challenging to appraise something that does not exist yet! Of course, there are experts who do just that every day. Construction lenders work with appraisers to analyze your project when you apply for a loan. They review the specifications of your construction project and compare it with other existing constructions of similar specifications.

They then draw conclusions regarding the possible worth of the construction in the future. It is very important to get a good appraisal if your construction loan is to be accepted. You can get an independent appraisal if you want, but your lender will insist on conducting their own.

 

How to Prepare an Apartment Pro Forma

The term “Pro Forma” is short for Pro Forma Operating Statement. A Pro Forma is an annual operating budget for an income property, and it is probably the most important single document in an income property loan package. An experienced processor will always assemble the package with the Pro Forma as one of the very first items that the lender sees.

Because you have been provided a form entitled “Pro Forma Operating Statement” the actual preparation of a Pro Forma is merely a matter of filling in the blanks.

The numbers you choose to insert, however, must be supportable and well documented. The stakes are high. If a lender does not accept your Pro Forma, he will not take the time to prepare one of his own. He will merely select a very conservative operating expense ratio such as 40 to 45%. Operating expenses of 40 to 45% will kill most deals.

Remember, the loan size rather than the interest rate or points is usually the sticking point in income property negotiations.

At this time, please take a moment to review the attached Pro Forma Operating Statement form. Since this is a universal form, only a few of the blanks will be filled in for any individual property.

First let us discuss Gross Scheduled Rents. You should usually use the current actual rent roll. Insert in your rent roll the market of any vacant units.

The only time a lender will accept projected rents is if the rent increase letters have already been sent. It is helpful, but not mandatory, to include a few samples of the rent increase letters that have been mailed. However, be careful not to scare your client away by asking for copies.

The new rent level should be no further off than 90 days. Then if the lender objects, the Placement Officer can suggest that the file be put aside for a few weeks until the rent increase is in effect. Invariably the lender ends up accepting the projected rents now. Another time you can get away with projected rents is if the apartment building is located in a city with rent control, and the annual increases are scheduled to take effect within 90 days.

There were times in the late 1980’s when lenders would consider in certain areas, such as the Bay Area, the greater Los Angeles area and the greater San Diego area, a Vacancy Allowance of less than 5%. Those days are gone. You must use at least 5% today.

The lender may insist on 7% to 10% for Sacramento, the Central Valley and most outlying California areas; however, you should still insert 5% for these areas and pray.

Borrowers will often protest with claims of actual vacancy rates of 2% to 3%. In these cases, remind your borrower that a Vacancy Allowance is really a shortened version of Vacancy and Collection Loss Allowance. Anyone in business eventually gets a few bounced checks and deadbeats.

Inserting the actual operating expenses is greatly simplified if a well-done appraisal arrives with the package. In this case, simply insert the expenses as listed in the appraisal, and footnote them as follows:

Based on the MAI appraiser’s estimate.

However, you usually should not order an appraisal until the lender has reviewed the package and the borrower has accepted in writing the lender’s proposal. Therefore, you must be prepared to estimate the expenses yourself, and you should document them well.

Few borrowers, however, keep records that current, and you must be careful not to scare the borrower away by demanding that he spend hours poring over his records.

Be careful not to double count the insurance premium or real estate taxes by annualizing them. Remember that these expenses are just paid once or twice a year. The best source for the annual real estate taxes is the preliminary report. You might find the annual insurance premium in the previous year’s tax return, or you might simply have to ask the borrower or the borrower’s fire insurance agent.

Here are a couple of useful rules of thumb. Because of Proposition 13, real estate taxes in California are computed by taking 1.25% of the original purchase price. To compute an estimate of a fire insurance premium, use $5.50 per thousand dollars of coverage. Therefore, if the sum of the existing 1st mortgage and your new 2nd mortgage is $787,000; you can take 787 times $5.50 to arrive at a very rough estimate of the new fire insurance premium.

There will be times where the borrower simply has only a few months operating history. Examples include properties taken back in foreclosure, and recent purchases. In cases like this, ask the borrower to prepare for you a Utility Statement. A Utility Statement is a breakdown of the building’s various monthly utility expenses for the last 12 months or less. You can annualize these numbers for your Pro Forma.

The real estate taxes can be obtained from a prelim and the insurance premium from the borrower.

To estimate Repairs and Maintenance, use between 6-10% of Effective Gross Income, depending on the age of the property and the quality of the tenants.

In the absence of specific offsite management numbers, you should use 5% of Effective Gross Income. This is what most professional property management firms charge. Onsite management should be handled as follows.

Show the full market rent of the resident manager’s unit on your rent roll and on your Gross Scheduled Rents.

Then list as an expense under Management Onsite the difference between the market rent of the unit and what the resident manager actually pays. This difference is known as a rent credit, and is fully taxable under the IRS codes. If the resident manager receives a small salary in addition to a rent credit on his unit, be sure to include this as well.

Many small units do not have resident managers, and lenders will accept this. However, even if a building is owner managed, you should include an off-site Management expense of 5% of Effective Gross Income.

The reason why is because in the event of a foreclosure, the lender will have to hire a professional property management firm to manage the property.

Setting up a Real Estate Holding Company or Real Estate LLC

A real estate holding company is designed to reduce an investor’s personal exposure to the risks and liabilities inherent with owning investment property.

Commonly referred to as real estate LLC’s, holding companies also isolate income from a property or specific properties, simplifying bookkeeping and taxes.

Starting a real estate holding company is recommended for most investors.

How to Start a Real Estate Holding Company in 6 Steps

Starting a real estate holding company is generally pretty simple and inexpensive. While a number of business structures are appropriate for a real estate holding company, (S corp, C corp, sole prop, or LLP) a real estate LLC is the most common. It doesn’t require a lot of administration, and you can manage it yourself as a managing member of the LLC or you can designate a manager. You can set up the real estate LLC online or with the help of an attorney.

Here are the six steps to starting a real estate holding company:

1. Set Up the LLC for Your Real Estate Holdings

You need to set up the LLC that you’re going to put your properties in. Part of this setup process includes choosing a name for your holding company. You also need to register it with your state, register it with the IRS, and receive an employee identification number (EIN).

Keep in mind that the name of your business can’t be the same as any other LLC on file in your state. The business name must end in LLC, Limited Liability Company, Ltd, or some variation that shows the type of entity it is. Each state has its own LLC office, and it’s generally associated with the Secretary of State’s Office.

You can call them, or it may be possible for your lawyer to check online to see if a name is already being used.

File Paperwork for Your LLC

We recommend working with a real estate attorney because specific paperwork is needed for an LLC. However, if you use Rocket Lawyer, they will give you a list of paperwork to file with instructions on how to do so.

Generally, you need to get your EIN number first; the order in which you create articles of incorporation and an operating agreement doesn’t matter.

You will need the following documentation when you form an LLC:

EIN Number

You can apply for an EIN number online on the IRS’ site. It gives you directions for applying. Basically, you can apply online if your business is located in the United States or its territories.

You usually get your EIN number immediately, as soon as you apply. You will then need this EIN number for the rest of the LLC filing process.

Articles of Incorporation

The articles of organization are generally filed at the Secretary of State’s Office, sometimes referred to as the state’s LLC filing office. You can find the office information on your state’s website. It’s a simple document that usually lists the company’s name and address. Some states also list the members of the LLC.

Operating Agreement

An LLC can have one member or multiple members, and these members will be listed on the LLC operating agreement. This operating agreement defines the roles of each of the members, and should be signed by each member.

An LLC operating agreement should include:

Ownership and operations rules

Members percentage interests

Members rights and responsibilities

Voting

Management duties

How profits and losses are handled

Once you have your business entity established, many people assume the next step is to transfer ownership of a property to it. But to reap all the benefits of a holding company, there are actually a few more steps you can’t afford to miss.

This is especially true if you’ve yet to purchase the real estate that will be held by your new real estate LLC.

2. Open Separate Checking Accounts

It’s important to have separate personal and business checking accounts to keep your real estate LLC funds separate from your personal funds. This better protects the owner’s assets and helps with bookkeeping. It can also help you track your business purchases.

Another benefit of opening a separate checking account for your real estate LLC is budgeting your funds and preparing for tax time.

3. Choose a Professional to Work With

You may want to hire a professional to help you set up the LLC, especially if it’s your first one. This helps cut down on time and limits your liability, since a professional is doing it for you.

Usually, investors use a real estate attorney in their state to set up the real estate holding company. However, some investors prefer to do it themselves.

Pros and cons of working with an attorney to set up your holding company include:

Pros:

Streamlined process

Professional who knows the state laws and is familiar with the filing process

All paperwork is filed for you and you don’t need to purchase templates

You don’t need to worry about paying separate fees

Less time consuming since the attorney handles the entire process

Cons:

More expensive; an attorney is usually three times or more expensive than setting up the LLC on your own

You have to spend time finding a reputable attorney

You’re depending on someone else to correctly do everything for you within IRS and state guidelines

If you choose to work with a real estate attorney, ask a friend, family member or other real estate professional for a referral.

Ask for the professional’s credentials and look at their website (including their customer reviews) and make sure they’re familiar with real estate law in your state.

4. Find a Property & Get It Under Contract

The main goal of establishing the real estate holding company is to use it to protect your personal assets and your properties, so it’s important to know how to find and purchase investment properties. You want to find a property that fits in with your investment goals and your budget.

Once you have a real estate LLC set up, you can fix and flip a property. Generally, a fix-and-flipper usually wants something that they can fix up and build sweat equity in by rehabbing the house and updating kitchens, bathrooms, etc.

However, a buy-and-hold investor looks more at the long-term earning potential of the property and wants to know how much they can get for renting out the property. They also want to choose an up-and-coming or stable neighborhood, where property prices continue to steadily increase and the value of their real estate investment goes up.

Before you get too deep into the property hunt, you will want to choose a lender and get a pre-approval letter. This pre-approval letter is needed to look at properties with a realtor and is needed before you can make an offer on a property (unless you’re paying cash).

For more information on choosing a neighborhood and narrowing your property search down to one property, check out our guide to buying a multifamily property. It also outlines the steps for choosing your lender and getting pre-approved.

5. Secure Financing for Your Rental Property

You’re already pre-approved, so now you need to finish the lender’s application process. During this time, the lender will carry out something called underwriting, where they thoroughly check the information on your loan application as well as your supporting documents.

Some of the required documents include:

Complete mortgage application

Purchase contract

Documentation showing where down payment is coming from (e.g., a gift letter)

Property details

List of current assets and liabilities

Rent roll, copies of leases

Lenders generally have different funding times depending on the type of loan, but usually, a hard money loan funds within 15 days, a conforming loan closes within 30 to 45 days, and a commercial loan can take up to 60 days to close.

6. Close on the Property

The last step to starting a real estate holding company is closing on the property.

This closing is when the deed to the property switches names and the new owner gets the keys to the property at something called a settlement. This usually takes about 60 to 90 minutes and is generally conducted at a title company or realtor’s office.

Prior to closing, you will have your financing in place and the mortgage company will give you a copy of your closing costs, so you know what to expect at settlement. You will be required to bring certified funds, your identification, proof of property insurance if you’re financing the property, and your checkbook for any additional expenses.

A closing is the same regardless of whether you are purchasing the property in your name or an LLC’s name.

The proceedings are the same but the required paperwork is different. For example, the title company will need a copy of your articles of organization and your operating agreement to verify the members of the LLC. This is mostly done to prevent fraud.

The deed and all of the closing documents will be in the LLC’s name. This means that when you get the utilities switched over, they will also be in the LLC’s name.

Keep a copy of your LLC documents handy because you will need them and your identification to show that you are authorized to sign on the LLC’s behalf.

GSA’s Real Estate Leasing Policies

When looking for a starting point for examining the federal government’s real estate policies, it is best to start with the GSA’s Public Building Service (PBS). PBS is the arm of the GSA that leases space for numerous federal agencies.

PBS is also the caretaker of federal properties the GSA owns, occupies, and leases to other federal agencies across the country. PBS’s real estate policies are numerous and address almost all the federal government’s real estate leasing activities since the formation of the GSA in 1949.

Narrowing the focus to policies currently in place finds that PBS sets the policy baseline for the federal government’s real estate policy.

This policy baseline is best described by PBS as its “basic policy” to lease quality space that is the best value to the federal government, is located in a central business district (with some exceptions), is accessible by persons with disabilities, and is sustainable and provides a safe work environment.

The bulk of PBS’s real estate policies are found in the PBS Leasing Desk Guide (Desk Guide). The Desk Guide sets forth the guiding principles and policies for GSA employees engaged in government real estate contract activities.

The policies in the Desk Guide also apply to federal agencies leasing space under delegated authority from the GSA. In 1996 the GSA administrator granted GSA leasing authority to all federal agencies.

Known as “delegated authority,” this change permits federal agencies to lease their own space without using the GSA as their real estate representative.

If a federal agency uses the GSA for its real estate needs, that agency becomes either a tenant in federally owned GSA-managed space or a subtenant to the GSA, with the GSA holding the primary lease with the private-sector property owner.

The GSA has a separate occupancy agreement with the federal agency to which it is subleasing the space. The costs for managing that space are usually added to the lease payments made to the GSA by the subtenant leasing the space from the GSA.

The GSA typically has special clauses in its occupancy agreements that allows the federal agency to vacate the leased space before GSA’s lease term expires with the private-sector landlord; the GSA is typically left paying the remainder of the lease term rents regardless of the whether the space is still occupied by the federal agency subtenant.

As recently as 2014, the GSA made changes to its leasing delegation authorization process. Some of these modifications centralize the GSA delegation authorization process and require additional oversight of federal agencies, which now are required to show they can manage and administer their own leases.

To better understand the GSA’s leasing authority and the GSA’s authority to delegate this authority to other federal agencies, it is best to look at the United States Code (USC) Title 40, formally known as the Public Buildings Act of 1959.9

Top Markets for Multifamily Development

Research firms CoStar and MFP look at busiest markets for new apartment construction as a percentage of existing inventory.

Population is growing quickly in all of the cities where developers are planning to build the newest apartments, according to CoStar data. In addition, development can be a long, slow process. In many of these cities, the number of apartments completed over the last year is much lower than the number of apartments that developers have announced they plan to build.

1. Miami

Building cranes still tower over downtown Miami—the busiest market in the U.S. for the planned development of multifamily housing. Immigration has kept the population of Miami growing, and that has kept developers busy planning new projects.

Miami is number one on CoStar’s list of markets with more than 50,000 units with the highest share of apartments under construction as a percentage of existing inventory.

Developers had 16,777 new units of multifamily housing in some phase of the development process in Miami in the third quarter of 2018, according to CoStar. That works out to 11.4 percent of the current inventory.

Research firm MPF counts 9,656 new rental apartments under construction in the Miami-Miami Beach-Kendell, Fla. metro area. (MPF only counts apartments that are physically under construction, instead of counting projects that have been announced, but may still be arranging their financing or building permits.) That’s equal to 3.3 percent of the inventory across the broader metro area.

2. Salt Lake City

Salt Lake City is friendly to business and relatively inexpensive compared to many cities. That has kept its economy strong, helping to make the city number two on CoStar’s list of top markets for new development.

Developers had 6,527 new units of multifamily housing in some phase of the development process in Salt Lake City in the third quarter of 2018, according to CoStar. That works out to 9.9 percent of the current inventory.

MPF counts 3,237 new rental apartments under construction in the Salt Lake City-Ogden-Clearfield, Utah metro area. That’s equal to 3.1 percent of the inventory across the broader metro area.

3. Nashville, Tenn.

Good schools, as well as jobs created by looser regulation and lower taxes, continue to draw new residents to Nashville, Tenn

Developers had 10,220 new units of multifamily housing in some phase of the development process in Nashville in the third quarter of 2018, according to CoStar. That works out to 8.7 percent of the current inventory.

MPF counts 5,329 new rental apartments under construction in the Nashville-Murfreesboro-Franklin metro area. That’s equal to 3.6 percent of the inventory across the broader metro area.

4. Boston

Smaller cities in the Southern and Western U.S. dominate CoStar’s list of top markets for new development, but there are a few exceptions.

Developers had 17,707 new units of multifamily housing in some phase of the development process in Boston in the third quarter of 2018, according to CoStar. That works out to 8.6 percent of the current inventory.

But only a few of these planned apartments have actually broken ground. MPF counted far fewer new rental apartments under construction in the Boston metro area, equal to just 1.9 percent of the inventory across the broader metro area. The difference between MPF and CoStar shows how long it can take for a planned project to be approved by local officials and actually start construction.

5. Jacksonville, Fla.

Jacksonville, Fla. is number five on CoStar’s list of top markets for new development.

Developers had 6,906 new units of multifamily housing in some phase of the development process in Jacksonville, Fla. in the third quarter of 2018, according to CoStar. That works out to 8.2 percent of the current inventory.

MPF counts 3,988 new rental apartments under construction in the Jacksonville metro area. That’s equal to 3.5 percent of the inventory across the broader metro area.

6. Seattle

A booming tech economy has kept developers interested in building apartments in Seattle, perhaps too interested. “The volume of new supply has dampened rent growth,” says Greg Willett, chief economist with RealPage Inc., a provider of property management software and services.

Seattle is the only city on CoStar’s list of top cities for new development where rents fell over the year the ended in the third quarter on 2018. It is number five on CoStar’s list of top markets for new development.

Developers had 24,388 new units of multifamily housing in some phase of the development process in Seattle in the third quarter of 2018, according to CoStar. That works out to 7.7 percent of the current inventory.

MPF counts 15,986 new rental apartments under construction in the Seattle metro area. That’s equal to 4.8 percent of the inventory across the broader metro area, making it tie with Charlotte, N.C. for number three on MPF’s list of top markets for new construction.

7. Denver

Education is the chief driver of the strong demand for new apartments in Denver, which is number seven on CoStar’s list of top markets for new development.

Developers had 16,699 new units of multifamily housing in some phase of the development process in Denver in the third quarter of 2018, according to CoStar. That works out to 7.1 percent of the current inventory.

MPF counts 12,624 new rental apartments under construction in the Denver-Aurora-Lakewood metro area. That’s equal to 4.4 percent of the inventory across the broader metro area, making it number seven on MPF’s list of top markets for new construction.

8. East Bay, Calif.

Just across the Bay from San Francisco, developers are busy in towns like Oakland and Berkeley, Calif. The area is number eight on CoStar’s list of top markets for new development.

Developers had 11,632 new units of multifamily housing in some phase of the development process in the East Bay in the third quarter of 2018, according to CoStar. That works out to 7.0 percent of the current inventory.

MPF counts 6,936 new rental apartments under construction in the Oakland-Hayward-Berkeley metro area. That’s equal to 3.4 percent of the inventory across the metro area.

9. Charlotte, N.C.

Charlotte is number nine on CoStar’s list of top markets for new development.

Developers had 11,065 new units of multifamily housing in some phase of the development process in Charlotte in the third quarter of 2018, according to CoStar. That works out to 6.8 percent of the current inventory.

MPF counts 8,634 new rental apartments under construction in the Charlotte-Concord-Gastonia metro area. That’s equal to 4.8 percent of the inventory across the broader metro area, making it tied with Seattle for number three on MPF’s list of top markets for new construction.

10. Austin, Texas

Austin is number 10 on CoStar’s list of top markets for new development.

Developers had 13,991 new units of multifamily housing in some phase of the development process in Austin in the third quarter of 2018, according to CoStar. That works out to 6.7 percent of the current inventory.

MPF counts 10,282 new rental apartments under construction in the Austin-Round Rock metro area. That’s equal to 4.3 percent of the inventory across the broader metro area, making it number eight on MPF’s list of top markets for new construction.

Choosing a Commercial Property Management Firm

In today’s complex real estate markets, selecting the right commercial property management firm is one of the most important decisions investors can make. Trained, experienced, and creative real estate managers can obtain the maximum return on an asset by improving cash flow, retaining tenants, and increasing value. With more than 10,000 property management firms in the United States, investors are often at a loss about how to select one that will meet their personal investment objectives.

Frequently, investors seek advice on property management firms from commercial brokers who represent them in transactions. Recommending a qualified real estate manager may be part of your contract with a client or an added service that is especially helpful to out-of-state or foreign investors who are not familiar with property managers in your area.

Whoever you recommend naturally will reflect back on you, ideally enhancing your clients’ perception of you. Although you are probably familiar with the basics of property management, this may be a good time to acquaint yourself with the process of evaluating real estate property managers. It may be particularly timely if you are thinking of putting your own property in the hands of a qualified professional-a decision that may lead to more-profitable use of your time. Whether you’re lining up a firm to recommend to a client or seeking the services yourself, these guidelines will help you find the right fit between property and management service.

What to Look For

For the perfect fit, a management company’s expertise should match an investor’s needs. Is the real estate investment an office, an industrial building, a multifamily housing complex, or a suburban strip center? Does the building have a vacancy problem, a maintenance problem, or a marketing problem?

Investigate the experience of a firm by asking what other properties like yours (or your client’s) it manages, how long it has managed the properties, and what have been the results of its management.

Find out the type of investors with whom the property management firm usually deals. Does it manage for individual investors or does it specialize in working with institutional investors? The firm you are considering must have expertise in serving your type of investor as well as your type of property, because the reporting requirements of each investor type will be different.

Reputation Counts

A good company will have positive word-of-mouth in the industry, so ask around and determine a firm’s standing in the business community. It should have a solid reputation for providing professional management services, as well as for integrity and honesty.

Though the number of years in the business is not necessarily a determinant of professionalism, it does reflect experience and longevity. However, do not assume the best service always comes with age: a company new on the scene may make up for lack of experience through aggressive management or thorough attention to detail.

Organizational stability is a related matter. How long have individual members been with the firm? Do you deal with the same manager or group of managers who bring continuity to the property, or is there considerable staff turnover? Lack of stability could signify poor company management or lack of financial stability; whatever the cause, you want consistent service and familiar faces that tenants recognize and get to know, so rapid staff turnover should raise a warning flag.

Look for Accreditation

As in other areas of real estate, a property management firm that is accredited is set apart from other firms as having met higher standards. Some CCIMs specialize in property management and many of them may also have specialized designations such as Certified Property Manager (CPM), Real Property Administrator (RPA), and Certified Shopping Center Manager (CSM). The Institute of Real Estate Management (IREM) awards the Accredited Management Organization (AMO) designation to firms that meet its criteria.

Look for a firm with accredited staff and leadership. These members must meet stringent education and experience requirements in fiscal and operational management.

Of course, firms whose employees hold other, related designations of expertise are likely to have a broader, deeper understanding of the many aspects of managing investment real estate. The property management company with whom you work should be experienced and flexible; knowledgeable about accounting, architecture, leasing, sales, law, appraisal, marketing and maintenance; and honest and forthright in dealing with clients, tenants, and their own employees. Ask about the workload of the manager who will be assigned to your account. You should know how often the manager will make site visits.

Check Insurance

Inquire about a firm’s insurance coverage and make sure that the management staff is familiar with loss prevention and risk management programs. Make sure the firm has a fidelity bond to protect against the loss of money or property through the fraudulent or dishonest acts of employees. It must also carry depositor’s forgery-and-alterations insurance to protect against loss due to forgery or alteration of checks, drafts, and promissory notes. A firm also should adhere to requirements for professional liability insurance.

Finally, avoid property management firms with conflicts of interest that may prevent you or your client from getting the most value. Ask the firm to disclose any companies that it may own or use exclusively, such as landscaping or maintenance firms. Where there is potential conflict, make sure the management firm employs competitive bidding procedures and is willing to provide evidence of this. The firm should make every effort to take full advantage of discounts, purchasing opportunities, and other ethical means at its disposal when purchasing or contracting for supplies and services on behalf of the client.

What Services to Expect

Property management firms can provide a broad array or a limited number of services, depending upon a client’s needs. Do not assume that a certain service is provided automatically by the firm. Ask what specific services it will provide and, once you or your client decides on a firm, work out a comprehensive written management agreement with the firm. The agreement will outline services the firm will provide, letting the owner know exactly what to expect from the property management firm and what the services will cost.

Commercial property management firms typically provide the following services.

Management Planning. A commercial management company can analyze the business environment and the specific property within that environment, set out a marketing strategy, and recommend how a client’s objectives can best be fulfilled.

Financial Reporting. Record keeping and financial reporting are key services provided by management firms. Ask to see samples of the firm’s reporting documents.

Budgeting. The management firm develops and monitors the property’s budget, which covers everything from maintenance to marketing, personnel to operations. As the year unfolds, the manager should inform the owner of any necessary budgetary adjustments and explain why they are needed.

Maintenance Programs. Commercial property management firms provide monthly maintenance cost monitoring and the development and implementation of preventative maintenance programs.

Market Rent Analysis. Management firms will provide an analysis of market rents and those of the competition, changes in area demographics, and anticipated absorption levels.

Marketing Programs. Firms can develop and implement marketing programs that improve the image of properties and ensure successful leasing. A comprehensive program may include such essential marketing tools as brochures, advertisements, special events, property newsletters, videos, maps, and site signs.

Rent Collection. The collection of rent, including a daily record of deposits, is a basic service provided by management firms. A cash management system, which includes investment returns on rental dollars collected, should also be implemented.

Lease Negotiation. A firm is usually responsible for negotiating all tenant leases and renewals, or, in the alternative, for recommending the best leasing company in the area and coordinating leasing activities with that company.

Tenant Relations. The professional property management firm is attentive to tenants’ needs and responds to their concerns immediately. It should have a written policy for receiving and resolving tenant concerns.

Purchasing Procedures. Firms establish procedures for the purchase of all equipment, supplies, contracted building services, and insurance coverage.

Contract Specifications. Commercial property managers prepare specifications for all contracted work (such as tenant improvement construction), obtain competitive bids, and supervise the projects.

Documented Procedures. Commercial management companies establish documented procedures to ensure compliance with all federal, state, county, and local governmental statutes as well as administrative regulations, ordinances, and fire, health, and safety codes.

Making the Final Selection

Whether evaluating firms for yourself or your clients, look for a commercial management firm that provides the type of management services needed. Not all management firms manage all types of properties. As you get close to making a final decision, meet again with the selected firm to review its proposal and specifications. This is the best time to clear up uncertainties and negotiate the management agreement-don’t wait until after the contract has been signed.

Remember that property management fees are directly proportional to the quality and quantity of services provided. Management fees generally are based upon a percentage of collections, though they vary in different parts of the country for different types of properties and are strictly negotiable between the parties. Percentage fees can be based on different portions-or all-of the income stream. For example, with shopping centers, the fees for basic services can be a percentage of net rent collections, gross rent collections including triple net expenses and advertising and marketing fees, a flat fee up to a certain level of income and a percentage after that, or some other calculation. There can also be a percentage administrative fee applied only to triple nets, in addition to a basic percentage of net or gross income.

Alternative fee structures include a flat fee or a flat fee plus a percentage of income. Factors for consideration include the size of the property, average rent level, difficulty in managing the property, location, amount of time needed to manage the property, and any special reporting required.

More than ever, investors must select commercial management teams with care. The right property management firm will provide the management expertise, financial stability, professional excellence, and integrity required in today’s competitive real estate market.

12 Trends Shaping the Commercial Real Estate Tech Industry in 2018 and Beyond

Commercial Real Estate Investing 2018

Nearly 95% of households own a computer and nearly 90% have high speed internet. There are many trends that are shaping the commercial real estate tech industry over this year.

1: More Changes to Work Spaces – The millennial effect began the work space changes, now Gen Z is bringing a tech focus to commercial real estate in the workplace, retail, and multifamily.

2: More Innovative Housing Options – There is a housing shortage growing across the country. Although far fewer GenX and millennial adults’ own homes than previous generations, the new trend of boomers staying at home combined with over 150 million Gen Z and millennial homebuyers entering the market, housing options are going to get more innovative including 3D printed housing.

3: The “Silver Tsunami” Hits the CRE Market – Boomers by and large have left the workforce, now they are moving to senior housing. More active and living longer than previous generations, commercial investors are eyeing multifamily assets in order to be in position when the silver tsunami soon hits commercial real estate in full force.

4: More Disruptive Commercial Real Estate Tech Coming Online – Co-working spaces, proptech firms, and many new fintech tools are going to further disrupt the commercial real estate market.

5: AI Will Transform Big Data Analysis – Big data analysis is going to continue to be enhanced and strengthened by automation and artificial intelligence. Smart leases, lead prospecting, customer management, and agent recruiting will all be impacted over 2018 by AI technology.

6: Energy Saving Smart Features Will Become Standard – Millennials and Gen Z care more about the environment but seniors and millennials also want more energy savings through Smart technology built into homes and apartments. Expect many of these features to become standard this year.

7: New Commercial Real Estate Tech Companies Offering AI Enhanced Platforms – New commercial real estate tech firms are going to continue to expand the powers of AI specifically for commercial real estate agents and brokers. Expect more platforms to come online offering increasingly detailed and machine learned analysis for sales as well as property management.

8: Blockchain Will Continue to Evolve in the Commercial Real Estate Sector – Blockchain’s complete disruption to commercial real estate appears to be at least a few years off, but expect to see the technology continue to evolve in this sector this year.

9: Data Centers in Secondary Cities Will Grow in Demand – Secondary cities will continue to attract new investors as e-commerce and the IoT require the use of more data centers. Places like Portland, Virginia, and North Carolina have become prime targets for commercial real estate investors.

10: Office Buildings Will Continue to Shrink – Office spaces are shrinking and most businesses don’t even need a building. Co-working and remote work will continue to shrink the modern office building transforming small retail spaces into office space.

11: Tenants and Buyers Will Demand Tech Infrastructure Upgrades – In order to support Smart technology, the infrastructure of buildings has to be wired for wireless. Expect more buyers and tenants to demand those upgrades rather than pay less for assets without modern infrastructure.

12: Construction and Design Continue to be Further Automated – Housing shortages, rising prices, and conservation-minded millennial’s will continue to push 3D home building technology over 2018 to include automated house printers, carpenters, and new design software to make incredible strides in 3D house printing.

 

Guide to HUD Commercial Loans

The articles provide a basic understanding of HUD loans for commercial real estate investment.

What is HUD?

HUD stands for “Housing and Urban Development”, which is the US federal government agency that administers the Federal Housing Administration (FHA) multifamily mortgage insurance. As it relates to the multifamily loan program, HUD and FHA are often used interchangeably in referencing these programs that are 100% insured by the government in the event there is a default on the property.

Why get a HUD loan?

HUD loans provide extremely favorable terms. Refinancing a stabilized asset would fall under HUD’s 223(f) program, which provides a 35-year term and amortization, non-recourse loan at up to 80% loan to value, at a fixed.

On a construction or substantial rehab deal, the 221(d)(4) program provides even more generous terms at 85% loan to cost (non-recourse) with a 40-year term and amortization.

Generally, the only change in terms with HUD would be fluctuations of interest rates at the time of rate lock. A HUD loan really provides the greatest appeal for sponsors because it is a long-term permanent debt option, but can be readily paid off at any time with a simple tax-deductible prepayment penalty, or fully assumed by a new property owner after a simple 0.05%, one-time fee.

These features can lead to a premium price in the event of a sale, as the buyer has the option to either pay off the loan or assume the existing debt with a below market interest rate.

Isn’t HUD only for affordable housing?

No! This is the biggest misconception about the HUD lending program, as generally everyone assumes that HUD is only applicable for Section 8 and affordable housing.

However, there is a very big difference between a HUD property, which is owned and operated by the government to provide affordable housing, and a property that takes advantage of the HUD loan.

Many Class A, market-rate Multi-family properties across the country can qualify for a HUD loan. HUD loans can also be combined with local tax credits or municipal grants to create a compelling investment scenario.

Does HUD provide construction loans?

Yes! For multifamily developments, HUD has the 221(d)(4) construction loan program for developers of both market rate and affordable housing.

This program is non-recourse and provides borrowers with up to 85% loan to cost, with a 40-year term and amortization at a fixed rate. Unlike conventional bank financing, these terms are not subject to change along with market conditions which has made the 221(d)(4) particularly attractive in today’s economic environment.

How long is the typical process to secure a HUD loan?

Arranging a HUD loan takes a bit of patience, which is generally the biggest drawback for using the program. While the processing time depends on whether the property is stabilized (program 223(f)) or construction (program 221(d)(4)), it generally takes 5–9 months from engagement to closing, with construction being the longer of the two.

This longer lead time occurs because the FHA lender and HUD each underwrite the transaction. However, bridge-to-HUD financing may be available to facilitate acquisition financing when waiting 6 months is not a viable option to secure the permanent debt.

Does Rental Income Qualify For The New 20% Section 199 [A] IRS Deduction

Section 199 A was added to the Internal Revenue Code under the Tax Cuts and Jobs Act of 2017 to provide taxpayers with a 20% deduction from income attributable to qualifying trades or businesses.

One immediate question under the new law was whether the definition of a “trade or business” would include a landlord who is in the business of collecting rent and performing only incidental duties under a Lease Agreement.

This will make a big difference for landlords who have a net profit because rent income exceeds depreciation, interest and operating deductions.

New Proposed Regulations were issued on August 8th which provide some degree of guidance, but also confusion.

The new Proposed Regulations indicate that if a taxpayer has an active business, like a factory or an engineering firm, and directly or indirectly leases property to the firm, then the net income from the leasing arrangement will be considered to be an active trade or business for Section 199A purposes.

On the other hand, where the tenant under an arrangement is not an active business that is affiliated by at least 50% ownership with the landlord, then by the terms of the Proposed Regulations a definition of “trade or business” which comes from Internal Revenue Code Section 162 will be used.  Section 162 dates back to 1926, and controls when a taxpayer can take deductions for expenses incurred in an “active trade or business.”

The court cases interpreting Section 162 have not always been kind to landlords.  In particular, there needs to be something more than a long-term triple net lease where a landlord just collects rent and does very little else in order to qualify as being a trade or business.

A landlord that provides active management relating to a particular building, or at least administers common area expenses, should probably be able to take the Section 199A deduction, but someone who simply bought a building that is triple net leased to a large company where the large company does everything and simply sends a check to the property owner will probably not qualify, although this is not clear.

One example in the Proposed Regulations provides that an individual who manages and leases vacant property to an airport is able to take the deduction.

The primary focus of this example was not whether this landowner was in a “trade or business,” but it seems like the only reason the IRS would have had to mention that the landlord manages the airport property would be to show that it must be an active trade or business.

A second example in the Proposed Regulations provides the same language for a parking garage rental.

Based upon these examples, it appears that taxpayers who have passive triple net leases and are not otherwise active in the leasing business will not qualify for this 20% deduction, although landlords under triple net lease arrangements might be engaged in continuous due diligence, negotiating, and buying and selling properties that are triple net leased and therefore be considered to be in an active trade or business for the purposes of this deduction.

Proposed Regulations constitute the thinking of the IRS, and these particular Proposed Regulations are only binding on taxpayers to the extent that taxpayers would choose to rely upon them.  In other words, they cannot be used by the IRS against the taxpayer.

Hopefully, the real estate lobby will be able to convince the IRS and the Treasury Department that final Regulations should be more tolerant.

In the meantime, individuals and entities taxed as sole proprietors, S corporations, or partnerships that have triple net lease situations like those described above should consider making the arrangement more active by providing management to the tenant, or engaging in activities that would make the business of being a triple net lease landlord more active than what might otherwise be the case.

This article does not constitute a full and complete discussion of everything that someone would need to know about Section 199A and real estate leasing.  The Section 199A rules have a number of requirements that may need to be met.

For example, high earner taxpayers who wish to take a 199A deduction attributable to rental income will need to satisfy a wage and/or Qualified Property test that may require that they pay a minimum amount of wages and/or have a minimum amount of depreciable property based upon the original cost of depreciable components.

Commercial Real Estate Investing & What You Need to Know

Commercial Real Estate Investing

When you think of real estate investing, commercial property is usually the first thing that comes to mind. After all, commercial development is where the money is at. As lucrative as it may be, commercial property is not the type of investment you want to dive head-first into without an education.

How Commercial Real Estate Investing Works

When people invest in commercial real estate, they’re investing in real property, and that property is used to generate a profit.

Commercial real estate can include:

Warehouses

Apartment complexes

Shopping malls

Industrial property

Office buildings

Hotels

Medical centers

Farmland

Any property that is used for commercial purposes, or to run a business, is considered commercial property.

Investments generate money in two ways:

Leases, which generate rental income

Appreciation of property value over time

Finding property in an in-demand area is the key to making a smart investment.

The Pros and Cons of Commercial Property Investing

Any kind of property – whether commercial or residential – can be a good investment. But in most cases, commercial properties offer a better return on investment. Still, there are drawbacks that need to be considered. Before you make a decision on whether to invest in commercial real estate, you should understand the pros and cons.

The Pros of Commercial Real Estate Investing

There are plenty of benefits to investing in commercial real estate. These include:

Income

The most obvious advantage is income potential. With commercial real estate, the income-generating potential is generally much higher than with residential property investing.

Commercial properties typically have an annual return of 6%-12%, depending on the location. Single family home properties usually have a return of 1%-4% at most.

Fewer Active Responsibilities

Residential properties usually require more hands-on management. As a landlord, you’re on the hook for maintenance and other management responsibilities 24/7.

With commercial properties, your tenants will typically only be on the premises during business hours: 9am-5pm. Property insurance and maintenance may also be the responsibility of the tenant, depending on the commercial lease. These are called triple net leases, and they’re favored by larger brands that want to maintain a specific image, such as Starbucks or Walgreens.

Commercial tenants will be more likely to sign longer leases, which will save you the hassle of having to find tenants on a regular basis.

Better Financing Terms

Financing terms are usually more favorable and flexible for commercial tenants. Some owners can obtain 100% financing on a first or second mortgage, which is something you can’t do with residential properties.

Professional Relationships

The relationship between commercial property owners and tenants is usually a professional one. You’re dealing with a business – not a family or individual. Interactions are usually more courteous and professional as a result.

Better Price Evaluation

Commercial property is usually easier to evaluate in terms of pricing because you can see the current owner’s income statement. That statement will give you a good idea of a fair price for the property.

With residential properties, pricing is usually based more on emotion than anything else.

The Cons of Commercial Real Estate Investing

While there are plenty of advantages to investing in real estate, there are also some disadvantages that need to be considered.

Bad Management

Do-it-yourself property management may be okay with a residential property, but you’ll need to hire a professional to manage a commercial property. Special licensing is typically required to handle the maintenance tasks associated with commercial real estate.

What happens if you get stuck with a bad management team? If they slack on their responsibilities or treat tenants in an unprofessional manner, this can reflect badly on you as a landlord and may even get you in legal trouble.

The fact that you have to hire a professional to manage the property may also be a disadvantage to some investors. Hiring a management company comes with added expenses and other concerns that you wouldn’t have with a residential property.

Property management companies usually charge between 5% and 10% of the rent revenue in fees.

Fierce Competition

Commercial real estate can be fiercely competitive, depending on your location. With more competition, you may wind up paying a lot more for property than you had anticipated.

Greater Risks

Unlike with residential properties, commercial properties have public visitors. The more public visitors on the preemies, the greater the risk of someone getting injured. Liability concerns may be a turn-off to you as an investor.

Big Initial Investment

By nature, commercial real estate is more expensive than residential real estate. That means you’ll need to make a bigger initial investment.

The large initial investment makes it difficult for some investors to get their foot in the door with commercial real estate.

How to Secure Good Deals

With any real estate investment, being able to spot a good deal is the key to finding success. The top real estate professionals know exactly what to look for when combing through properties.

First, make sure that you have an exit strategy. A good deal is a deal that you know you can walk away from.

Along with having an “out,” you also want to learn how to properly assess a property. Know how to look for damages and estimate the cost of repairs. Learn how to assess the risk of investing in each property you look at. And don’t forget to estimate the costs of buying and managing the property to make sure it fits your financial goals.

As for finding a good opportunity, that part is more of an art than a science. But if you’re just getting started, you’ll want to look at the neighborhood the property is located in. Is the area in high demand? Is the local economy thriving, or slacking?

Talk to neighbors. Get a feel for the area. Trust your instincts.

When evaluating a property, there are a few things you can look at to assess its value:

NOI (Net Operating Income). This is calculated by subtracting operating expenses from the first-year gross operating income. You only want to consider properties with a positive NOI.

Cash on Cash: This involves comparing the first-year performance of nearby competing properties.

Cap Rate: A property’s capitalization rate can be used to calculate the value of the property. This method is often used when evaluating apartment complexes and small strip malls.

How Commercial Properties are Sold

Commercial properties are sold much in the same way residential properties are sold. But instead of considering the wants and needs of families and individuals, you need to consider the investor’s perspective.

What type of buyer are you aiming for? Someone looking for a 100% turnkey property, or someone who wants to make improvements on the property?

The purchase process may take longer than with a residential property, and the evaluation process is certainly more complex. But generally, properties are sold in the same way any other real estate property is sold.

If you’re thinking of investing in commercial real estate, weigh the pros and cons carefully and take the time to educate yourself on the process. When it comes time to search, look for sellers who are motivated and ready to sell for less than the market value of the property. Unmotivated sellers are far less willing to negotiate, which will make it harder to secure a good deal.

3 Reasons Why Investing in Real Estate Is Easier Than Ever

More millionaires today have invested in real estate than any other asset class. While real estate investing may seem intimidating or out of reach, new technology is changing the game by increasing access and decreasing investment minimums.

The following three tips for getting ahead in real estate:

1. Start conservatively.

The first and most important aspect to remember when investing is preserving money.

Make sure your investments will perform well in both an up and down economy.”

2. Don’t worry about diversification — just start.

A lot of people are so worried about investing intelligently and maintaining diversification that they never begin investing.

If you are fairly conservative with your early investments, you can earn while you learn.”

3. Technology is changing the game and inviting new players.

Before the passage of the JOBS Act in 2012, it was illegal for unaccredited investors to invest in non-traded REIT offerings. The only options were the stock market and possibly a fixer upper if you were willing to endure the hassle of being a landlord.

Information, technology and transparency are removing the intimidating shroud that has historically covered the real estate investment market — making that leap from saver to investor that much easier for the future generations of millionaires.