How business owners can navigate the market and purchase commercial property Featured

8:01pm EDT July 31, 2012
How business owners can navigate the market and purchase commercial property

If you’re a business owner looking to purchase a building to house or expand your business, you have a lot to consider. You’ve come to realize buying is better than leasing, and building equity in your own property is better than building equity for your landlord.

However, your real estate experience might only extend to purchasing a residential property, leaving you with questions regarding the potential benefits and misconceptions, if your business will qualify for financing and what is involved in the application process.

“Over 80 percent of applicants we work with are first-time commercial building buyers. Many come to us with a baseline level of knowledge of real estate, which is often limited to residential only,” says Ken Mannina, senior vice president and regional sales manager for Bridge Bank. “What these applicants learn during the loan process is that their objectives are consistent with those of the lender. The applicant wants a loan to purchase a sound economic asset that has utility and tangible value, and the lender wants to have as collateral for their loan the exact same thing.”

Smart Business spoke with Mannina about what business owners should understand about the process of purchasing commercial real estate.

What is the profile of a typical commercial real estate financing applicant?

They are business owners who seek financing for the purchase or construction of a building to house their business. About half of the applicants request additional financing for construction to go with the purchase. Most of them own closely held businesses that are not publicly traded but are owned by one or two individuals or a group of family members. They’re seeking to stabilize their occupancy costs and eliminate their exposure to escalating rents and dealing with landlords.

What types of businesses are looking for commercial real estate financing and why?

Banks work with all types of businesses, including manufacturers, service businesses, retailers, distributors, contractors and investors. These business owners have some commercial real estate objective in mind — buy a building, refinance a building, improvements or repairs, or buy out a partner in the building. As owner/users, there is heavy emphasis on U.S. Small Business Administration lending. In that type of lending, the leverage, or debt to equity ratio, that’s available to the borrower is high — up to 90 percent — which means you get more debt and require less equity.

When do the lender’s and applicant’s objectives coincide?

There are several that center on the property they’re buying. The lender will review a title report and order an appraisal and environmental report and possibly structural or mechanical reports. These reports provide the lender with data that will support or reject the negotiated purchase price while providing a good sense of the integrity of the property. For buyers, these reports will give them assurance that what they’re buying can, at some point, be sold and financed by a new buyer, thereby returning their initial investment; though that hinges on the market conditions at the time.

The lender’s approach to analyzing the property and assessing its value will involve quantifying the amount of rental income it can generate and reviewing the lease and sales comparables that are presented in the appraisal to confirm that they are suitable for valuing the property.

How can a business owner best prepare to purchase a commercial building?

The best way is with pre-qualification from your lender. In the case of a business owner, the underwriting and analysis focus on the business he or she owns. When they’re trying to purchase a building to house their business, their commercial real estate broker will require them to get a pre-qualification letter, which will be submitted with an offer to purchase. Much like residential real estate, a prospective buyer who is prepared and can demonstrate his or her capacity to borrow will be better received by sellers and brokers.

Are there misconceptions about commercial real estate financing?

Yes, one is that you need to make a 30 percent down payment to get a commercial real estate loan. However, through the SBA, you can get a loan with only 10 percent down.

Another misconception is that commercial real estate is too costly. When compared to residential real estate, commercial costs more because of its larger size, but the return on your investment may be greater. Also, a rent-versus-buy comparison that takes into account the tax benefits of ownership often reveals commercial real estate occupancy costs are less than renting.

Finally, there is a misconception about the importance of location. While it is critical in retail, it isn’t otherwise because commercial properties are purchased for their utility and income, not location or aesthetics.

What does a first-time buyer need to understand about financing a commercial real estate purchase?

When selecting a lender, clearly you’ll be looking at rates and fees, but first timers need to be educated on how they’re qualifying, how the transaction is going to proceed and what’s going to be asked of them. They can use the answers to those questions to set their expectations realistically regarding how much money they’re going to have to invest on the front end and how they’ll transition from a leased property to a purchased property.

The buyer also should be mindful of the fact that the due diligence performed by the bank during the underwriting process, like the appraisal and environmental reports, will server buyers’ needs as well as the bank’s needs. They can look to their lender to advise them on all those things.

Ken Mannina is senior vice president and regional sales manager for Bridge Bank. Reach him at (408) 556-8336 or ken.mannina@bridgebank.com.

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