Commercial Property Investment Mistakes and How to Avoid Them

You’ve probably heard about the commercial real estate bubble, here’s the ugly truth that lenders and other insiders don’t want you to know. Despite all the hype, not every commercial property is in trouble. The key for you as an investor is to avoid certain pitfalls and learn from other investor’s mistakes.

Before the economic and credit boom that has led into the recent downturn, conventional lenders capped loan amounts at 65 percent of the value of the property. This means that your $10 million commercial property would qualify for a maximum loan of $6.5 million. The current problems with commercial property investments started when hedge funds and private equity lenders began offering much higher loan to value ratios, meaning they would lend against your investment property with as much as 80 percent of the value of the real estate.

Mistakes Made by Commercial Investors

Some investors decided to refinance their $10 million commercial property for $8 million and get $1.5 million out tax-free! What seemed like a great deal at the time has come back to ruin the typical commercial property investment. The problem was that these loans needed to be refinanced after five years. Owners who pulled money out of their investments like this began down a path that has led to the troubles we are seeing now.

Fast forward from then to now and you’ll see that the entire economic climate has changed. Most sources of financing for commercial real estate have dried up. Owners with a property that needs to be refinanced are finding that unless the LTV ratio is 65% or less and the property is performing perfectly, it’s almost impossible to get refinancing for their commercial property investment.

You can’t tap into those hedge funds and private equity firms because many of them have gone out of business. So you are left with two options:

1) Create a workout with the existing lender where they refrain from foreclosing against your property in exchange for a slight increase in the interest rate, or other benefit that you can give the lender. In some cases the benefit to the lender is that they don’t need to take your property back. The truth is that the lender really doesn’t want to take back your property if they can avoid it.

2) Bring other investors into your deal by offering them a decent rate of return on their investment along with giving them a chunk of your equity. Make sure to contact a commercial property investment attorney who can help make sure that you meet all of the SEC guidelines if this is the path that you choose to go down.

What Makes a Safe Commercial Property Investment

The problem with many owners of commercial properties today is that they got into a deal with a bigger loan than they should have. Now, these commercial property owners can’t ride out the recession because the loans are coming due and they’re short, or worse, upside-down.

Investment rule #1

-Leave the equity in your property.

· Successful property owners don’t pull out their equity at the top of an up cycle; they leave the equity in their commercial property investment so they can ride out the downturns. The “commercial meltdown” doesn’t apply to property owners who left their equity untouched. While it’s true that the commercial property values have come down from a high peak. The typical commercial real estate investment is far more valuable today than it was 10 or 15 years ago.

Investment rule #2

-Stick with conventional lenders.

· By taking a short term hard money loan commercial owners placed themselves at the mercy of the fickle market. A conventional lender would not have financed more than 65 percent of the property value, allowing the owner with a cushion against fluctuating property values.

When structured correctly, your real estate investment may not provide you with an overabundance of excitement, but during times like these, a stable, performing real estate investment is just fine.

Are Mortgage Brokers Evil?

In the 1990’s everyone was crying about how evil lawyers and contractors are. Lawyer jokes were common tales told around cocktail tables and functions. At the turn of the decade, mortgage brokers were added to the list and they too are under a lot of scrutiny and the pun of many jokes.

Are mortgage brokers evil? The answer is simple no. Are there shady mortgage brokers that will try to con you out of your hard earned money? Off course! Every profession has bad apples! Are these bad apples the majority? No, let’s discuss why.

1) Mortgage brokers want your business – Most mortgage brokers work on commission and rely heavily on word of mouth advertising to generate clients. Furthermore, 50% of a good mortgage brokers business is repeat customers; mortgage brokers have an incentive to service their customers properly and keep them in the long haul.

2) The competition keeps them honest – Given the influx of many new mortgage brokers in the last couple of years, the mortgage business is a very competitive field. There are a large number of brokers competing for a small base of customers. Brokers will almost always give you their best rate in order not to loose your business. Remember, brokers don’t get paid until they fund the loan. This is also a good reason to speak to at least four different brokers from different companies, let them compete for your loan and you will almost always shine at the end.

3) The law is there to protect you – God bless America! We have many laws in this country that govern mortgage brokers and let me tell you that the lending laws are not very forgiving in this country. Mortgage brokers will take a lot of heat when they do shady deals and all it takes is one simple complaint. Make sure you get everything in writing from your broker and you will be protected, simply as that.

The Bad about Mortgage Brokers

Mortgage brokers do not fund your loan themselves; they use wholesale lender and banks to find you the right loan and save you money. The problem arises in how they are compensated. Wholesale lenders do not set interest rates, nor do the brokers. The going interest is dictated by the secondary mortgage securities market. How rates are dictated is a discussion by itself, which is unimportant in our discussion.

Lets simple assume the going “par rate” for a 30 year fixed mortgage is 6%. If the mortgage broker funds your loan at 6% the mortgage broker makes zero in commissions. The higher the interest rate they close your loan with, the more commission they receive. Moreover, if they charge you an interest rate below 6%, they have to pay money out of their own pocket to fund the loan, or charge the client what is called a “discount point” to get the rate they want. Luckily the law has a cap on how much of a commission a broker can make on a particular loan. Nonetheless, your goal should be to lower the interest rate as much as possible.

What is the lesson to be learned here, when mortgage brokers quote you a rate, they have room to lower it; unless they gave you par pricing, which is not likely. Given our example above a broker might quote you 6.5%, where the broker makes $2,000.00. If you are a good negotiator you can get the broker to lower the interest rate, where the broker only makes a $1,000.00 on the deal, you will save big bucks!

Be Careful Of the Fees

By law, a mortgage broker is permitted to charge you a fee for finding you the right loan. When negotiating, don’t neglect these fees. Find out what they are and make sure you talk to them about it. Fees are negotiable; don’t let anyone tell you otherwise. The thing to ask yourself for when looking at fees is, what am I paying this fee for, is it for an appraisal, notary service, processing etc? Is the fee there because something must be done to fund the loan and is nessesary or is the broker just trying to make some money off of me? Remember, the broker makes his money on the interest rate spread between what he charged you and what the “par rate” is. Fees outside of that are considered “Junk Fees” and should be avoided if possible. If the broker, charged you a super low rate, give him a little, they need to make money somewhere.

Pounding Your Mortgage Broker

To successfully get the best rate on your loan with a broker, keep in mind that the broker needs to make a living. If you grind them too much, chances are they will not take you seriously and simply not want to do the loan. Be reasonable, let the broker make money off of your loan and they will work hard to get you the lowest rate. The broker can go back to the wholesale lender and grind them for a lower rate, but if there is no money in it for the broker, there is no incentive.

What I suggest is to speak to a couple of different brokers and let them compete. This has been a very daunting task up until recently; luckily there are many good mortgage lender website online that will analyze your needs and match you up with four of the best lenders according to your situation. What would take days to do flipping through the yellow pages now takes 60 seconds online.

A Quick Commercial Property Investment Guide

As the residential investment property market becomes fierce, many investors are starting to recognise commercial property as a viable investment option. So, don’t put all your eggs in one basket and consider diversifying your investment portfolio by investing in commercial property.

What is Commercial Property?

The term commercial property (also referred to as commercial real estate, investment or income property) refers to building or land intended to generate a profit, either from capital gain or rental income.

What Type of Property is included in Commercial Real Estate?

Commercial real estate is classified as property assets that are primarily used for business purposes. Commercial real estate is commonly divided into the following categories:

1. Office buildings

2. Industrial property

3. Retail/Restaurant

4. Multifamily housing buildings and

5. Farm/Rural land.

In addition to the above, commercial real estate can include any other non-residential properties, such as:

>> Medical centres

>> Hotels

>> Warehouses

>> Malls and

>> Self-storage developments.

What are the differences between Commercial Property and Residential Property Investments?

When you invest in commercial real estate, you still expect to rent out your property and receive rental income from a tenant as you do when you purchase a residential property investment. However, the major difference between investing in commercial real estate compared to residential property is the Rental Agreement. With commercial real estate, the property is usually leased to a business under a detailed contract for a much longer period (e.g. three, five or ten years).

There are some other important differences such as:

>> The Tenant is usually called a Lessee;

>> Vacancies between tenancies can be longer;

>> Goods and Services Tax applies to commercial real estate (i.e. to the purchase price, rent received and any expenses in relation to the property); and

>> Maintenance costs are usually paid for by the Lessee, which means net rental income tends to be higher.

What is an Annual Return on Investment?

The “annual return on investment” is the amount earned on the investment property. The amount earned, is expressed as a percentage, and it is called the property’s “yield”.

So, if you are considering investing in commercial real estate. You should always ask yourself the following questions:

1. What return on investment will you get?

2. What is the property’s yield?

How is the Yield calculated?

Yield calculations are worked out by dividing the annual rental income on the property by how much the property costs to buy. For example:

Gross Yield = annual rental income (weekly rental income x 52) / property value x 100

This is best illustrated by using the following example:

>> Assuming you buy a property for $950,000; and

>> Rent the property out for $2,000 per week ($104,000 annually).

Your Gross Yield will be 10.9%. It will be calculated in the following way:

($104,000/ $950,000) x 100

If you want to invest in a commercial property, you need to keep in mind all the information mentioned here. You can seek help and guidance from a professionally qualified and expert finance broker, who specialises in obtaining the right funding for your investments.

Truly, having an independent and expert finance broker on your behalf can secure your eligibility for a commercial property loan, not to mention get you the best loan deal that suits your individual needs and objectives.