Buy low, sell high. We all know the rules of investing by now, though following them in an economic downturn requires a bit of courage and a lot of foresight. For business owners and investors considering commercial real estate purchases, the market is ripe with inventory at fair prices.
“Now is the time to buy,” says Craig Johnson, president and CEO of Franklin Bank, Southfield, Mich. “Essentially, what you buy today for 70 cents would have cost a dollar yesterday.”
Indeed, it’s a buyer’s market for those who have conserved cash and are prepared to commit to traditional terms and conditions. And business owners who are in the position to bid on properties now could realize returns once the economy rebounds.
Smart Business spoke to Johnson about what to expect in today’s commercial real estate market.
What opportunities exist today in the commercial real estate market?
With the current economic cycle, there are plenty of owner-operator businesses that may be experiencing financial difficulty and may need to sell. Investors who are having trouble leasing their properties may want to exit the market. Also, the number of commercial properties banks own is much greater now because of loan defaults and other circumstances. Whether you are a business owner looking for office space or an investor speculating properties to own and lease out, there are certainly a lot of choices out there. The key is to shop carefully, do your due diligence and determine whether a property is truly a good deal.
Any warnings for investors?
If you are an investor, be sure to stress-test the investment: be sure your pro formas make sense given the current economic cycle. In particular, get a strong feel for the property’s income potential. Understand its position in the marketplace relative to competing buildings.
Consider the old adage, location, location, location. Does the property you’re considering have a stigma? Some properties do not lease — sometimes for good reason; other times for no reason at all. You do not want to invest in a property like this, even if it’s a bargain-basement deal.
What about for business owners?
While the same rules of doing due diligence and recognizing the importance of a property’s location are true, there is less emphasis on a property’s potential to produce revenue. That is, unless you plan to own the building, occupy a portion of it and lease office space to tenants. Today’s market may be friendlier for business owners than for investors because most owner-operators are not buying with the intention to ‘flip’ the property and sell it for profit, or make a living off of rent revenues. While the availability of properties is appealing for both types of buyers, business owners may be more willing to take a risk on a ‘deal’ because their goal is to buy office space, not to attract and retain tenants.
How will building vacancy and current rental rates play into the deal?
If you buy a building that is vacant, ideally you should have a tenant lined up to lease the space. If not, you must understand the typical occupancy timeline for the property. Keep in mind that filling the building may be more difficult in this market, unless you are willing to pay for improvements to entice tenants. However, if you find a property with a good rental history or are willing to build out space for tenants, you can get a tremendous deal on a property that will pay back now in terms of rental revenue and appreciate in value over time.
What should business owners/investors expect regarding financing?
You will put more money down and, currently, pay slightly higher interest rates for commercial real estate loans. Investors may put an average 30 percent down, whereas in the past the typical requirement was about 20 percent down. Owner-operators may put 20 to 25 percent down but can take advantage of Small Business Association (SBA) loans, which can help them conserve cash and still fulfill banks’ down payment requirements. Don’t discount any loan opportunities, and strongly consider SBA lending. Also keep in mind that banks are seeking relationships, not single transactions. Banks want to pick up checking and savings account business and to leverage their cash management and payroll services. If you treat real estate financing as one piece of a total partnership, banks may be more willing to recognize the value in backing you in real estate investments.
The key in this market is to polish your strategy and understand your risk before buying commercial real estate. Make the deal transparent. Then enlist your banker before you need capital. Make financing part of the process, not the last step in your real estate transaction.
CRAIG JOHNSON is president and CEO of Franklin Bank, Southfield, Mich. Reach him at CLJohnson@franklinbank.com or (248) 358-6459.