How does this whole "Commercial Real Estate" thing work?
There's a location in my neighborhood that I've been eyeing for a while. It's a small retail strip, and with the recent boom in home sales, our area has become very hot. This particular location is part of a very small commercial block in the middle of a residential area, so good placement, and limited supply of space that will not be getting any bigger. The price is high, but we have a bit of a nest egg and could swing 20%. 

That being said, we have zero experience in real estate investment, commercial or otherwise. I have no idea what any of this would entail. I'm sure that it's a different beast than a residential rental property. What do I need to know? Googling "commercial real estate investment" yields a ton of garbage and little usable information. Thank you!
[{"id": "gjaiops", "text": "stay away from retail in all honesty", "replies": [{"id": "gjaiypv", "text": "Even if it's fully occupied right now? All the businesses currently occupying it have been there since well before the pandemic, and at least 3/5 are doing brisk business (2 takeout restaurants and a liquor store)", "replies": [{"id": "gjaja11", "text": "It depends on your personal risk appetite, however I work for a fairly large commercial firm and we are avoiding retail like the plague. The problem, in my opinion, is those small shops (especially now) don\u2019t have the same staying power as larger companies do. With increased volatility comes increased risk that a lot of people don\u2019t want right now", "replies": [{"id": "gjaog7n", "text": "There is a huge influx of people coming from the nearby metro area to our suburbs, driving the prices of homes way up. The space in question is part of a 10 store mini commercial zone that can't get any bigger. I know that retail in general is bad news right now, but the whole \"downtown revitalization\" thing is big around here, and this tiny area could be a hot little restaurant zone in the future. Maybe.", "replies": [{"id": "gjavahw", "text": "You keep saying things to the effect \"built out\" &amp; \"no more commercial\" as if supply of commercial real estate is the only factor.  Everyone else in this thread is trying to warn you *demand* for commercial real estate is all that matters and demand had been *massively* impacted; first by the internet and now by COVID.\n\nFundamentally, if one of those tenants leaves can you replace them at or above their current rent reasonably quickly? If not, are you getting a low enough price that you can weather a long vacancy or substantially reduced rent to fill the space?\n\nFinally, if this parcel is such a money maker and has such potential why is it for sale? There are plenty of valid reasons but you don't want to be the greater fool.", "replies": [{"id": "gjaw7kc", "text": "You're absolutely right. I don't know why it's on the market - it could be a huge money pit. The reason I keep mentioning the fact that it's in a limited area is because that's the factor that's making it stand out to me. I certainly wouldn't be considering a strip mall in a larger commercial area of my town. There are plenty of cheaper strip malls up for sale, and they're running 50% or more vacancies right now. \n\nI'm sure that I don't know if I know all of the right questions to ask, or if what I'm seeing as important is actually important. That was my whole reasoning for coming here and asking in the first place.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "gjamkq4", "text": "The appearance of doing well and a P&amp;L are two radically different things. There is likely not a restaurant in America that isn\u2019t struggling currently. The margins in that industry are generally razor thin as-is. Close them up for 2-3 months during lockdown and they\u2019re probably 2yrs+ to profitability if they make it that far.\n\nI bet the liquor store is killing it. All their sales went through the roof when they shut bars and indoor dining down, so they are a gem of a tenant in retail currently. \n\nAll of the above you would learn during due diligence. Retail is a crazy speculative buy for the foreseeable future. I would not want that to be my first foray into CRE investment especially with 2/5 of the tenants being restaurants, but that\u2019s just my perspective and with the giant caveat of \u201ceverything pencils at the right price.\u201d", "replies": [{"id": "gjansni", "text": "Thanks for the input. The restaurants I mentioned were takeout based (zero tables) prior to the pandemic, so their model didn't change too too much, I would think. That's why I was looking at them as a positive. Obviously I don't have inside info on them, but they're always doing brisk business when I drive by. The remaining 2 tenants are a hair salon/barber, and I have no clue how they're doing. \n\nI live in an area that's almost entirely built out, so no more commercial space will be forthcoming, especially not in this hyperlocal area. There are 10 total storefronts in this tiny commercial zone total, none of which lost their tenants during the pandemic. That's why I'm looking at this particular location. I wouldn't consider retail elsewhere, but this seems like an opportunity that won't be replicated soon.", "replies": [{"id": "gjapozf", "text": "That definitely helps if they\u2019ve always been takeout. Significantly lower overhead. Maybe not as life threatening as a traditional restaurant. \n\nHair salon and barber shops are cheap build outs and usually easily replaced if they vacate. \n\nIt\u2019s 100% occupied, so they are selling the income stream. Is there an asking cap rate or is this an off market deal?", "replies": [{"id": "gjassyv", "text": "It's on the market for 1.15m, and has been up for almost 2 months, which makes me think it's negotiable", "replies": [{"id": "gjavh4u", "text": "But what does it generate to justify a $1,150,000 price tag?", "replies": [], "depth": 7}, {"id": "gjaw87n", "text": "Do you know the NOI? Need that to find the cap rate ergo value. An unanchored neighborhood strip filled with mom and pops has basically all the possible market risks, so the cap rate and your underwriting should trend accordingly. My gut is this is overpriced.", "replies": [{"id": "gjay636", "text": "The listed NOI is $69,791, and the cap rate comes out to 0.60.", "replies": [{"id": "gjaz2dr", "text": "Having never seen the rent roll, leases, or even an aerial - no way in hell this trades anywhere near a 6 cap. This reeks of \"put it on the market and see what happens.\"", "replies": [{"id": "gjaz7h9", "text": "So how would someone go about sussing out the actual cap rate?\n\nEDIT: Given that I know absolutely nothing about commercial real estate, can you explain why you feel that number is so inaccurate? What's a reasonable cap rate for a comparable property?", "replies": [{"id": "gjb0lue", "text": "Variety of ways. Since this is new to you, you could engage a broker for an opinion of value and let them comb the market for comparable sales. Biggest issue is all of your comparable sales are going to be pre-covid so the cap rates aren't anywhere close to what they would be today. If I was throwing a number at the wall based on extremely limited info, this thing is probably an 8 cap at best.", "replies": [{"id": "gjb491v", "text": "I'm super hesitant to engage a broker, because this is a highly situtation dependent proposition. If this isn't worth pursuing, I don't want to waste anyone's time, you know?", "replies": [{"id": "gjbj6sk", "text": "This is a loser's mentality. If you think it's worth it.  Go for it. You'll never know until you ask.", "replies": [], "depth": 13}], "depth": 12}], "depth": 11}], "depth": 10}], "depth": 9}, {"id": "gjpx65f", "text": "Even in the best of times stuff like this trader for an 8.5 cap on in place at a 6 youre in for a really bad time. The only way that pencils is if there is near term rollover and the leases are below market but even still you will get fucked right now trying to roll retail leases to market", "replies": [], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "gjb2i5g", "text": "So restaurant margins are definitely thin and probably negative this year as you said- how would that impact the owner of the strip of land? Is there any risk from retail besides the possibility of them not being to pay?", "replies": [{"id": "gjcf7pi", "text": "The risk is a tenant(s) in default. It\u2019s expensive and time consuming to evict. It\u2019s expensive to put in a new tenant/operator. And so on. Extreme example, but retail is NNN. In theory, if your tenants aren\u2019t paying their rent, you might not be able to cover debt service or property taxes. Quick path to losing your asset. \n\nYet another generalization, but in my experience, once a tenant, especially a restaurant tenant, is in a hole, they never crawl out of it.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "gjaqfek", "text": "depends on where you live, Canada? US? I work in retail and I disagree with Head Huncho up there. DM me I could tell you more if I knew the market", "replies": [{"id": "gjarfdl", "text": "I'm in the \"greater metro NYC area\" if that helps. The \"retail\" in question is 2 solely takeout restaurants, 1 salon, 1 barber, and a liquor store.", "replies": [{"id": "gjasgrt", "text": "That is well out of my league then as I reside up in a smaller city in Canada. Retail as a whole is not going anywhere though, but it is changing drastically. A small retail strip like that will always be successful provided it's managed well.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gjakfwd", "text": "1. You'll find mortgages where the rate is fixed for only 5-10 years. When that term expires, you need to refinance. Amortization of 25 years is typical.\n2. Residential leases are typically gross leases. Commercial leases are typically net leases. You'll need to find out which expenses the tenants are paying during your due diligence process.\n3. Your lender may require you to put 25-35% down.\n4. Small residential (1-4 units) is typically priced based on comparable sales. Commercial real estate is typically priced based on net operating income (rent minus all expenses) and cap rate (yield).\n5. Leases run longer. 5-10 years with extensions of 5 years at a time. When the in place leases expire will be important to your lender.\n6. Expect 6-12 months to fill a vacancy (+12 months with the pandemic). You'll need a reserve for a Tenant Improvement allowance or to work out some other deal with your tenant for their build out of the space.\n7. Lease terms in general are much more wild west than residential leases.\n8. If you're confident the location will remain solid, and you can stomach the risk of retail in this century, you should be able to get a good deal because of the pandemic.", "replies": [{"id": "gjaqyel", "text": "Working backwards, number 8 is the biggie to me. The area is full - there is no more land to be built upon, and the residential area completely surrounds this little island of commerce. \n\n/7. the tenants have been there for a while, so the lease terms would generally transfer, no?\n\n/6. No vacancies currently, but your point is well taken. \n\nThe rest of the numbers I don't have specific thoughts on, but the info is invaluable, thank you!", "replies": [{"id": "gjaxnud", "text": "Yes, the lease terms will transfer. That includes the expiry dates. That could be 2022, 2027, 2032, or any year in between. Lenders like to see leases that will last beyond the term of the loan (e.g. if you get a 5 year loan, ideally your expiry dates are 2026 or later).\n\nAs an extension of the point above, if you purchase this property, then you will need to have a plan in place for what to do when those leases expire if the current tenants choose to move.\n\nFor the tenants whom you indicated elsewhere may not be doing too well because of the pandemic, you need a plan in place for what to do if you have to evict them for non-payment (or otherwise) and turn over their units.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gjal0u5", "text": "Hire a good lawyer or broker to give guidance. Is there anyone who you can partner with?", "replies": [{"id": "gjao128", "text": "I may be able to pull in other people with money to invest, but I currently have no connections in the business that could mentor/guide me in a partnership.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gjawm1o", "text": "Looks like we\u2019re in the same market. Sent you a DM.", "replies": [], "depth": 1}, {"id": "gjbdepa", "text": "Stay away from retail real estate.  It\u2019s high risk, can be challenging to backfill and lenders don\u2019t want to finance it.", "replies": [], "depth": 1}, {"id": "gjbe945", "text": "You should be able to see the current rent roll &amp; lease details prior to making an offer. I researched a similiar listing for a client recently and of the 6 spaces, only 3 were paying rent during covid. With eviction moratoriums in place - they are allowed to stay and operate. This is not to say there is not opportunity but I think getting thru covid and assorted variables - I would not go in with less than 40% cash on hand. 25-30% down and reserves for turnover and broker commission to get good tenants in. Likely the current tenants have under market rents and this will not be an income producing property until you have new leases. Goodluck", "replies": [], "depth": 1}, {"id": "gjchkbr", "text": "Broker, property manager and CPA. With good advisors it may work out quite well for you. Just expect to pay for the advice as you\u2019re learning. It\u2019ll be tuition money well spent.", "replies": [], "depth": 1}, {"id": "gjcwghl", "text": "Lenders will max out around 70 - 75% LTV and require some amount of liquidity left over after the acquisition (6 - 12 months Debt Service payments). Might be worth looking for a lower priced property if 20% down is your max.", "replies": [], "depth": 1}, {"id": "gjd1enl", "text": "**Here\u2019s a breakdown of what is required on the financing. I\u2019m sure some of this varies, especially with hard money lenders or if the loan amount is less than $1 million, but this is Reddit so, ya know**\n\n**Property**: \n\n* Current rent roll including a breakdown of all rents and CAM/net reimbursements\n\n* Leases (including any addendums and extensions)\n\n* Tenant estoppels to verify any COVID accommodations made by the current owner\n\n* 3-5 years of historical operating statements (you need at least 3 to gauge any trends, normalize expenses, and see how much has been spent on repairs, capital expenditures). If the property is for sale, the owner should have his ducks in a row and be able to provide 2020 results. If not, at least through Q3.\n\n* Physical Needs Assessment / Property Condition Report completed by an independent 3rd party (sorta necessary for someone with zero experience. This report will tell you the condition of the property and when you should forecast making big repairs)\n\n* Preliminary Title Report (can be ordered by you, but lenders typically have title companies they prefer)\n\n* Appraisal and any environmental reports will be ordered through your lender.\n\n**You**:\n\n* 2017-2019 tax returns including all schedules and supporting pages: Be prepared to explain anything and everything. For example, a capital gain on schedule D in 2017, they will ask about it. \n\n* Personal Financial Statement: Be prepared to explain anything and everything. You listed your house as an asset valued at $475,000. Where did you come up with that figure? Also, avoid listing personal property like a prized baseball card collection. It comes across as juvenile and banks never include these assets in their underwriting. \n\n* Verification of liquidity (bank statements, brokerage statements, or wherever you keep liquid assets)\n\n* Resume/Bio: Having achieved success in other industries or business investments establishes a proven track record. Do you know CRE? No, but you\u2019ve been successful in other ways. \n\n\n**Loan Terms**:\n\n* CRE loans have shorter terms (max 10 years), but are amortized over 20-30 years. In other words, a balloon payment at loan maturity. The loan term for this particular property will probably depend on when the leases mature. \n\n* The loan amount will be based on the lesser of a maximum loan to value (LTV) or a minimum debt service coverage ratio (DSCR or DCR). This varies per lender, but don\u2019t be surprised by LOIs with a maximum LTV below 70% and a minimum DSCR of at least 1.35x based on bank underwriting which usually includes assumptions for vacancy, replacement reserves, mgt fees, etc.\n\n* You will have to personally guarantee the loan unless you are okay with a &lt;50% LTV\n\n* Depending on when the existing leases mature, you could potentially have to put up cash in a bank controlled deposit account for future tenant improvements and leasing commissions.\n\n* Don\u2019t be surprised if the bank also requires a payment reserve account with at least 3 months of principal and interest (could be up to 12 months). This is something new some banks are requiring with hospitality and retail properties due to COVID.\n\n* Because you have zero experience, the bank might also require a cash sweep account for all rents and expenses. In other words, the bank won\u2019t let you touch any income from the property. All of the income gets set aside for future repairs and improvements. \n\n* Depending on the loan amount, you may still need to provide the rent roll, operating statement, your tax return, and PFS annually. Loans less than $1-3 million typically have stipulations that you have to provide this info when requested, but not necessarily annually.\n\nGiven this property has unique, favorable attributes", "replies": [{"id": "gjdarmv", "text": "This is super helpful, thank you!", "replies": [], "depth": 2}, {"id": "glu5eix", "text": "Looking in to CRE.  Why does anyone do this?  It seems like it just barely beats index investing, cash flow is nonexistent, a whole lot more work, and you don't really get access to the returns until you sell in 5-10 years.  At least most of the return appears to be in the form of equity / appreciation (although it appears even appreciation is dependent on raising rent faster than taxes and expenses go up).\n\nUnless you find some hidden gem, which is what everyone is looking for.", "replies": [{"id": "glvbfz0", "text": "**Why does anyone do this?** Isn\u2019t doing something you enjoy while making a boatload of cash the American dream? I personally \u201cdo this\u201d on the finance side because I think it\u2019s really fun, endlessly interesting, and I\u2019m really REALLY GOOD at my job.\n\nMy successful clients do this because they think it\u2019s fun and interesting too. No shade on golf buddy John loan officer/broker types, but I connect with clients because I have a sheer love of the CRE game, not golf.\n\nThat\u2019s why we do it, and my clients certainly aren\u2019t anomalies that magically got lucky or found hidden gems. If you are interested in CRE, you need to look harder because it isn\u2019t a big secret that CRE is a lucrative industry.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gl17xlm", "text": "Lease expiration dates are going to be huge here. If the leases have less than 5 years remaining, the lender will be underwriting the loan to less than 70% LTV and maybe as low as 60% for a sponsor without CRE experience. Let us know the terms if you end up going through due diligence!", "replies": [], "depth": 1}]