Buyer Fundamentals

This following is an effort to provide an overview of the buying process. As with leasing and other parts of commercial real estate there is enough complexity in each of the parts of buying alone to warrant a full book. As I write this and depending upon feedback I will expand each idea as much as is practical.

Key Points in the process:

  1. Buyer requirements evaluation – What I need…I think
  2. Ownership cost notes to understand before buying – HVAC costs how much?
  3. Site Selection / Market Evaluation – Is this where I should be?
  4. Locating properties – Where in the world…?
  5. Property Valuation – It’s worth how much?
  6. Due Diligence – What the heck is this thing actually?
  7. Financing – How am I going to pay for this?
  8. Contract Process and timeline – What is taking so long?
  9. Things to watch out for – What’s an estoppel?

Buyer Requirements:

As a buyer the first step is an evaluation of known business requirements and an attempt to forecast future needs and requirements to build a an outline of what you should be looking for. This is not easy. It can change completely during the search process and in some cases can derail the entire process if you’re not clear on what you’re looking for.

What is your business? Does it require visibility or is it a destination? How many employees do you have? How many will you have in five years? Do you have regular deliveries that require larger trucks, rail or even barge access? Are there demographic targets you’re trying to hit like national chains do or does specific location even matter to your business?

This initial step and evaluation can take a substantial amount of time to catalog and value each of the specific requirements you have and things you are hoping to achieve with a location. You will need to understand each and know which are absolute requirements and which can be stretched, pulled or even completely dropped.

Keep in mind as you do this that it is very unlikely you will find a location that gives you everything you’re looking for and most will likely only hit half or fewer of your requirements and you will need to figure out how to make due or otherwise workaround limitations.

The other huge part of this initial evaluation has to do with the budget requirements of a new space / building. How much can you actually spend? How much can you spend on the building / unit? On utilities? on buildout? On all new furniture to fill that awesome new space? Moving is expensive. There are ways to scale back and places where you can cut costs but you need to evaluate everything to understand where you have room to give.

For all of these requirements you need to consider not just your current needs but to project your business at least five years into the future to evaluate whether your needs are going to substantially change. Are you growing your business and if so will your new space / building accommodate that growth? Hard questions but they need to be considered.

Real estate – especially commercial real estate – is a very illiquid asset, meaning that it takes time, lots and lots of time, and money to complete a transaction so you want to get it as right as you are able to.

Ownership Cost Notes

There are many things you will learn on your first building purchase not the least of which is how expensive maintenance can be.

Starting with basic operating costs (utilities; insurance; taxes; etc) and expanding to include maintenance and improvements expenses can pile up. A key to minimizing expenses is to do your due diligence before buying so you’re able to forecast, as best as possible, potential expenses.

Utility costs can be similar to a triple net lease where all expenses are passed through or they can expand exponentially if you are one of multiple tenants in a building. Insurance will be higher as you will be covering full replacement of the building now since you own it. If you have other space leased to tenants you may be responsible for HVAC or roof replacement depending on how your lease is written.

Maintenance can be a serious burden. A new HVAC unit can start at ~$5,000 and get more expensive quickly as the building size or complexity grows. While they can last 20 + years with regular maintenance when they go out it can be a big deal. If you’re lucky advances in technology will have made a more efficient unit more cost effective to select as a replacement and with more luck you won’t have to do any duct modifications. That’s just HVAC. Every system in a building has the potential to be costly depending on the type of failure.

Best practices suggest a maintenance budget as a percentage of the building cost to be funneled into a dedicated account available for emergency repairs and planned maintenance projects. At the OCD end of the spectrum you can find owners who have full replacement and maintenance timelines and plans for each and every system in a building. While not required and typically only done in larger portfolios by dedicated building managers these kinds of plans can be very helpful for minimizing the strain (financial and mental) of dealing with system issues.

As you explore and tour properties you will hear the term ‘Deferred Maintenance’. It’s a fancy way of saying that the property needs work. When said with raised eyebrows it’s usually a good time to run the other way. When repairs and upkeep are not done for long enough, just like a house, the value of any building can plummet. Be wary of ‘deals’ where you just have to remediate some deferred maintenance. Costs go up quick in commercial real estate. Can you find deals that just need a bit of fix up? Sure but you shouldn’t count on them. Having a trustworthy contractor available to help you evaluate condition and costs will prove invaluable in helping you gage whether the needed repairs are viable.

Keep in mind as well with deferred maintenance that many lenders will not lend if they know there’s too much work needed or they’ll make you get a construction to permanent loan scenario. As opposed to a home a lender is typically far more interested in the condition and usability of a structure before lending.

Site Selection

The art of site selection has spawned entire careers and multimillion dollar businesses. Figuring out where to buy your building can be a weed field that’s hard to figure out with the added bonus that if you pick badly it can cost you financially. The short and sweet basics are to review your basic requirements and begin to outline from those what areas will be viable. Start broad and work your way down to a more focused geographical area. For example if you are a retailer looking to buy a building for your business you can eliminate industrial and office parks as a retail use will likely not be allowed.

You can also work in reverse provided you have a sense of the most ideal location, this is more typical. Using the retail example again you can begin to look at ‘main and main’ and then expand out from there until you find an opportunity that fits all your requirements the best.

Just like a home search you should create a list of requirements based on your business needs and then begin looking for as close a match as you can find. Remember that you will not get everything you want in a building. You might get the location but not the ideal size, or layout, or price. This is why it’s critical to have an acceptable range for each of your criteria not simply a single target.

Considering physical location for your business you should consider factors like who will be utilizing the location (employees and or customers?); what your spatial requirements are (usable square footage, high ceilings, loading dock, etc); what demographics are relevant (high income, college student, etc.) and any specific business requirements that must be accommodated (loading dock; outdoor patio seating, etc.).

Having at least a cursory understanding of the city zoning where you are looking to locate is wise. Cities have fairly specific use restrictions in general to segregate uses and setting up business outside of these rules generally requires something called a variance. You will have to demonstrate a strong case to get most cities to bend but it’s not impossible. With regards to zoning if you are looking to locate a business make sure before you close you have a strong consensus that your use is allowed in the building you are planning to buy. Do not ever assume that because your use is already being done in the building next door that it is allowed in the building you are considering. Always thoroughly research zoning for your planned business.

Even as an investor you will want to have some familiarity with the zoning limitations so you are able to target the right tenants for your property.

Zoning and variance approval can take a contract with a short due diligence timeline and make it very long if you require full approval of the use prior to closing and the city is slow to grant that approval. So, account for the potential delays. Having a contract take six months or even a year to close is not unusual. Be prepared for these kinds of twists and turns.