7 Barriers for New Commercial Investors | Break the Barrier!
At some point in time, most residential real estate investors recognize the outstanding opportunities available in the commercial realm. But, making the jump from residential to commercial real estate can seem a daunting prospect to new investors.
Investing in commercial real estate doesn’t need to be an insurmountable obstacle!
In this article, we’ll cover the following seven common barriers to entering this market - and how to overcome each one:
Commercial real estate experience
A solid team
Market research
Proper due diligence
Thorough underwriting
Access to - and understanding of - commercial financing
Adequate liquidity
1. Commercial Real Estate Experience
Would you open a restaurant without any experience in the restaurant industry? No, as this probably wouldn’t be a sound investment decision.
Similarly, breaking into the commercial real estate market with no experience in the field probably isn’t a great decision. While there are certainly plenty of parallels with residential real estate, commercial just has its own unique set of challenges and considerations.
But, this is a barrier that can be overcome. At one point in time, the world’s most successful commercial real estate investors had no experience in the field.
So, how do you tackle this challenge? First, you need to embrace a growth mindset, that is, be willing - and eager - to study and learn from your mistakes. As the saying goes, good judgement comes from experience, and experience comes from bad judgement.
Second, you can compensate for your lack of experience by surrounding yourself with a rockstar team. Commercial real estate isn’t an individual sport, which leads directly into the next challenge.
2. A Solid Team
Very few commercial real estate investors - if any - possess the intelligence, experience, and time to master all facets of a commercial deal. Some may focus on the numbers, others the construction, some the marketing - plus the countless other areas that need to combine to pull off a successful project.
Successful investors recognize this reality and overcome it by surrounding themselves with a phenomenal team of subject matter experts. While not an exhaustive list, here are some of the key team members necessary to a successful commercial real estate deal:
● Developer
● Project manager
● General contractor
● Real estate attorney
● Lender (for bridge and construction financing)
● Commercial mortgage broker (for permanent financing solutions)
● Architect and engineer
● Commercial insurance broker
● Sales and leasing representatives
● Property manager
And, once your team is assembled, it helps to keep it together - consistency breeds efficiency.
Need recommendations about setting up an effective commercial real estate team? Drop us a note!
3. Market Research
This is less a challenging barrier to overcome than one that is, unfortunately, often ignored.
Prior to even considering a commercial real estate deal, investors should conduct in-depth local market research (e.g. rental comps, local economic trends, industry competition, relevant cap rates, etc).
Though cliche, there’s truth to the saying that failing to plan means planning to fail. If you go into a deal without conducting your necessary market research, a seemingly profitable project can swing the other way in the blink of an eye.
And, in today’s era of big data, real estate market information is readily accessible online for investors looking to gain a deeper understanding of their local markets.
4. Proper Due Diligence
Related directly to market research, property due diligence is a key step to any commercial real estate deal.
Would you buy a car without test driving it? Hopefully not. Due diligence is the real estate analog to this situation - a thorough inspection of a property’s fundamentals prior to a deal, done to reduce uncertainty.
And, due diligence goes hand-in-hand with the next major barrier to new commercial real estate investors - effective underwriting.
5. Thorough Underwriting
The term underwriting has unfortunately taken on a mysterious aura, that is, people hear it thrown around plenty without really understanding what it means.
However, while easy to define, successfully underwriting a commercial deal takes a lot of experience and information from all members of the real estate team. As such, new investors would be wise to heed the above sections on experience and solid teams.
6. Access to - and Understanding of - Commercial Financing
Residential real estate financing is pretty straightforward - find a lender, apply for a loan, and get approved for a 30-year mortgage.
Commercial real estate loans have a vastly different set of characteristics (e.g. loan terms, amortization periods, carve-outs, covenants, debt coverage ratios, etc). Prior to even considering applying for a commercial loan, new investors need to understand how commercial loans work.
And, understanding commercial lending is no guarantee that you will actually be approved for a commercial real estate loan. Lenders assume far more risk in a commercial loan, and they’re going to want to ensure that the borrower has the assets, real estate experience, and pro forma operating budgets to justify taking this risk.
This isn’t to say that new investors can’t be approved for a commercial real estate loan - they certainly can. But, it’s critical to do the up-front research and preparation necessary to satisfy a commercial lender.
Drop us a note for help financing a commercial real estate deal.
7. Adequate Liquidity
Lastly - and related to access to a commercial loan - commercial real estate investors need to ensure they have adequate liquidity for a project’s life cycle. Broadly speaking, this means having cash-on-hand for the following items:
● Down payment and closing costs: the funds necessary to acquire the property and qualify for construction financing.
● Construction contingency: cash for when construction inevitably breaks budget (hedges against the need to tap additional credit).
● Operational reserve: once stabilized, these are the property’s reserve funds for “big-ticket” items like a roof repair (allows for capital expenditures without cutting into a property’s NOI).
In addition to meeting lender requirements, liquidity provides investors peace of mind. No deal in the history of commercial real estate has ever gone 100% according to plan, and having some extra cash gives investors - especially new ones - the comfort of knowing they can adapt to and overcome unexpected challenges.
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We recognize that, even after outlining the above information, entering the commercial real estate market can seem daunting to new investors.
That’s why we’re here to help. The Pocket Broker team lives and breathes commercial real estate, so drop us a note to see how we can help you achieve your unique objectives!