So here goes. Top 10 commercial real estate investor traps to watch out for:
1. Not knowing your surroundings: Look at the surrounding properties and the vacancy rate in the area. Will you be able to lease out your space at the same rate if one of your tenants leaves three months after you purchase the property? Are the rental rates cheaper across the street then for the investment you are purchasing?
2. Not knowing your tenant(s): Take a close look at the tenancy. How are their sales? Look at the rent to sales ratio. Does it make sense? Is it healthy? Most investors agree that the normal sales to rent ratio should be under 5% (i.e. your rent should be less than 5% of your sales). If it is, your tenant is thriving, is less likely to default and/or vacate, and is more likely to stay for a long time.
3. Failing to examine the building: It’s vital to know the health of the structure and roof. In most cases, it’s the landlord’s responsibility to maintain the structural and roof part of the building. Are there any roof leaks? If the building is not brand new (over 5 years old or so) then ask the following questions: When was the last time the roof was replaced or repaired? Is there a warranty on the roof? When does it expire, if there is one? Are there any structural defects in the building? During your due diligence period, if there are doubts, hire an engineer to inspect the property. Any unexpected building repairs after your purchase will hurt your bottom line. Plan for the unforeseen and make an offer accordingly.
4. Hidden fees: Review your leases carefully. Your tenants may be responsible for things you are not billing them for. In NNN leases, all operating costs are passed through to your tenants. Are you doing the same? In addition to NNN charges, some leases stipulate for additional administrative cost or management fees. Are taxes and CAM appropriately calculated? Do you pass through insurance costs? Review ALL leases carefully. Don’t just repeat the same charges the preceding investor had in the lease. You may be missing out on some additional income.
5. Corporate guarantees. On a marketing brochure, “Corporate Guaranteed Tenant” looks great. Keep in mind, most guarantees have limits. Review the guarantee language carefully, understand what their limits are and when they expire, before making your investment decision.
6. Demographic study and traffic counts: Not all tenants thrive in lower income areas. Some tenants do better in an area with more foot traffic, as opposed to car traffic. Every tenant is different. Reviewing the demographics of your investment may help you plan ahead if your building has a vacancy or an upcoming lease expiration.
7. Option to extend: Some leases have option clauses where a tenant has an option to extend the lease. Don’t confuse an option with the tenant’s base term. Remember it’s the tenant’s option to stay or leave. When buying a property look at an option as the possibility of tenant leaving. What would you do then?
8. Proof is in the pudding: When doing your due diligence prior to purchasing the property, be sure to ask for bank account statements of the operating account – preferably 12 months’ worth. Examining the statements, will allow you to assess whether the tenant has been paying on time or is behind, as well as whether or not the seller has given any rent concessions to the tenant without disclosing them in the due diligence material. You’ll also be able to see any untold or hidden expenses that the seller did not mention.
9. Environmental Concerns/Issues: The property may look great on the outside, but may have serious environmental problems. As an example, one investor told us about a tenant who was a Dry Cleaning Operator. Dry cleaning chemicals that have seeped into the ground will cause environmental issues. The investor’s number one step was to obtain the Phase 1 environmental report. It’s the landlord’s responsibility to resolve all environmental issues. Depending on the issue, environmental problems may cost thousands of dollars in the best case scenario, and closure of your property by a governmental agency at the worst. Avoid them. Ask the seller for a Phase 1 environmental report. If he/she doesn’t have it, order it.
10. Exit Strategy: Just like with any other investment know your exist strategy when you buy. What are your plans with the property? Is it a property you intend to sell in 5 to 10 years? Or hold on to it for 20 or more years. Knowing your exist strategy in advance of purchase may make a differences in the offer your present.
Tell us about your experience. As always, comments are welcome!