Mistakes that First-Time Investors Make in Commercial Real Estate Transactions

Investing in commercial real estate in Canada can be very lucrative. Rental income from commercial properties has historically been higher than residential rents, and there is typically more demand for commercial real estate.

However, investing in commercial real estate can be risky, and first-time investors sometimes learn this the hard way. The good news is that most of the mistakes novice investors make are avoidable. For first-time investors, we have compiled a list of common mistakes that real estate investors may make so that you know what to watch out for.

Insufficient Research

Researching the market is key to getting a property that you can lease out at an excellent rate. Researching the market will show you the demand for certain types of real estate. Some key things to investigate are:

• Broader economic trends such as employment rates, consumer spending and interest rates.
• Local market conditions such as average rental rates, vacancy rates, and the overall health of the local economy.
• The market dynamics of the specific type of commercial real estate you are interested in.
• Zoning and land use regulations, including anticipated changes.
• Available infrastructure.
• Demographic and socioeconomic factors that could affect the demand for different types of commercial spaces.

Note that many of these factors vary by the type of real estate. For example, transportation infrastructure requirements are very different for students living near campus than they are for suburban family restaurants and industrial complexes on the outskirts of a city.

Lack of Due Diligence

The due diligence process helps you evaluate the viability of the investment and the risks involved.

The process includes tasks such as researching the local market, checking for outstanding liens or other legal encumbrances on the property, reviewing the current leases for the properties and the creditworthiness of the tenants, examining any service contracts that are in place, ensuring that the property is in compliance with government rules and regulations such as zoning bylaws and environmental laws, looking over the past finances for the property, and scheduling a thorough property inspection.

Underestimating Up-front Costs

Commercial real estate investments generally have up-front costs beyond the cost of the property. For example, you may have to do some renovations, install a new security system, hire and train staff, and pay for marketing if you need more tenants.

The legal costs involved with purchasing a commercial property can also be considerable; there are more reports and disclosure statements than there are with residential properties, titles to be cleared, leases to be transferred, and other matters that are best handled by a lawyer. If there are actionable issues that crop up after the sale, such as serious structural issues the previous owner did not disclose, you may need a lawyer to follow up.

Overestimating Potential Returns

The anticipation of rental income can lead new investors to overestimate how much of this gross income will become net income. These calculations must include expenses such as insurance, property taxes, property maintenance, replacing expensive items such as heating and cooling equipment, and repairing damage from serious weather events. These costs can be much higher than new property owners initially expect. All properties should have a contingency fund for unexpected expenses so that you do not have to choose between maintaining the property and paying the mortgage.

Lack of a Good Business Plan

Novice investors may be tempted to jump into the commercial real estate market without a sound business plan. This plan should include:

• A detailed financial plan including the fine points of the financing structure, projected income and expenses, and key market metrics such as your projected return on investment.
• A property management plan that discusses how the property will be managed, a maintenance schedule, and tenant-management interaction protocols.
• Any plans for capital improvement you are considering, such as a new roof, major renovations, or the addition of amenities such as additional parking.
• Your marketing plan for attracting tenants and your tenant selection criteria.
• Your exit strategy, including conditions under which you may sell the property and a plan for how you will refinance the property if necessary.

Trying to Do Everything Yourself

Real estate investors tend to have an entrepreneurial mindset and believe that they can and must handle all parts of their business themselves. However, successful businesspeople use other people and their expertise constantly, and you should do the same.

As a first-time investor, you will likely go into the experience feeling capable and optimistic. This is energy that you need, and you can protect it by enlisting help from some key people. Your team can include a knowledgeable real estate broker, an excellent real estate lawyer, a reliable contractor, a financial advisor you can trust, and an experienced insurance broker. These experts will help you assess your risk from various angles, ensure that your venture remains financially viable, assist you in avoiding pitfalls, and help you overcome obstacles.

Conclusion

The first time you do anything, you will make mistakes. This is to be expected. The only trouble with mistakes in commercial real estate investing is that they can be very expensive. Research, preparation, and assembling a great team to support you are the most important keys to avoiding serious pitfalls in commercial real estate investing. When you have these pieces in place, you can continue your learning on the job.

Ready to explore some options? RE/MAX has brokers who specialize in commercial real estate. They understand the market and can help you choose a property that suits your needs, your budget, and your investment goals. Best of all, they work with first-time commercial real estate investors all the time; they will never let you feel as though your lack of experience is an obstacle to your investment success!