Owning commercial real estate is very different from having your own residential property. Single family homes are where you live. Shopping centers and restaurants are where you work. Laws that govern each type of property are different. There are many laws protecting owners of private residential property. Private land ownership is one of the core principles and values of the county.
The following are some features that are permitted in commercial landlord tenant lease agreements that are not permitted in residential landlord tenant lease agreements:
- There is no single "standard" commercial lease.
- There is no implied right of habitability.
- There is no statutory right to "repair and deduct" for property defects.
- Protections for residential foreclosures (extended time to vacate) do not apply.
- The 10% 60 day rent raise rule does not apply.
- The 60 day notice to quit rules (required for month to month tenancies over one year) do not apply.
- Statutory penalties for turning off utilities or changing locks (CC 789.3) do not apply.
- There is no specific limit to the amount of security deposit charged.
- The privacy protections of entry by landlord laws (CC 1954) do not apply.
- Landlords can accept a partial rent payment and still successfully evict with proper notice.
- Late charges which are excessive or illegal in residential tenancies may be acceptable for commercial ones.
- Rent control generally does not affect commercial rents.
- You may have to pay rent even if the space becomes damaged by such events as flood or fire.
1. Ask a lot of questions up front.
The first step in purchasing commercial real estate is knowing yourself, your situation, and what you're looking for. Here are some questions to consider:
- What kind of property are you looking for?
- Are you looking to use the building for your own business, rent it out, build equity, and/or something else?
- What kind of location do you need?
- Do you need to buy or lease the property?
- What is your situation regarding cash, financing, and/or ability to make a down payment?
- What is your risk tolerance?
- How much time can you commit to the property?
- How much work are you willing to put into the property?
- What skills/knowledge do you have regarding real estate construction and maintenance?
- Do you need a property manager?
- Are you willing to perform the duties of a landlord?
2. Learn some commercial real estate vocabulary.
There is a lot of vocabulary and acronyms in commercial real estate that you may not be familiar with. It's helpful to be savvy on some of the terms. This will make this process and working with people in the industry easier.
Here are some common terms:
- Loan-To-Value (LTV): A ratio of how much money you're asking from a lender vs. the total value of what you want to purchase.
- Debt Service Coverage Ratio (DSC): How much debt service charge can you manage with expected income.
- Capitalization Rate (Cap Rate): Income of the property divided by the total value of the property.
- Vacancy Rate: Percentage of properties that are vacant in a time period in a given area.
- Ad Valorem: A tax based on the assessed value of a piece of property.
3. Visit and consider many properties. Do you homework on each.
Consider and tour many different properties. Figure out what works and what doesn't about each of them for you. Consider the most important things for each including price, location, condition, and allowed uses. Your situation and needs are unique. The property should be a good fit in terms of price, location, uses, and investment required.
Here are other questions to consider for each property you are interested in:
- What is the property currently used for?
- What can/can't it be used for?
- What kind of rent/income does the property currently generate per year?
- What kinds of taxes and liens are there on the property?
- What things will need to be replaced or repaired soon?
- Why is the owner selling?
- How is the area around the property doing? Any major upcoming changes?
4. Find the experts you will need.
Buying commercial real estate is often a complex process. Many experts are available to help with some of the steps. Which and how many experts depends largely on the type of property you are purchasing, and what you will be using it for.
You may need to hire:
- Commercial real estate appraiser
- Commercial real estate lawyer
- Commercial realtor
- Environmental specialists
- General contractor
- Mortgage broker
5. Calculate your financing.
You will most likely need to get finance the purchase of the property. What type of bank, credit union, or mortgage company could you use? What kind of credit do you have, and what kind of interest rate do you expect to pay? Obtain a prequalification letter from a financing company before you put a bid on any property.
6. Make an offer.
Make an offer within the terms described in your prequalification letter. Have your real estate lawyer review the contract or agreement. Have your lawyer explain all details of the written agreements so you know exactly what your rights and obligations are.
7. Do your due diligence.
This is where the details matter. Money and property are about to change hands. You'll need to dot all the i's and cross all the t's. You can never know too much about the property you'll buy.
You'll generally need to do a title search, property appraisal, and property inspection. Title search provides valuable information such as boundary lines, location of the main building, property improvements, location of secondary buildings, identification of liens and easements (which are access rights by different service companies such as water, gas, telephone, railways and other utilities), etc.
You and the seller will need to find an escrow officer who will be the neutral 3rd party overseeing the transaction. They will help with the transfer of deeds and funds. They make sure both parties are protected in the transaction.
Finally, you (the buyer) are given a due diligence time period with which to make sure all the documentation about the property is correct. This is where you triple check that everything the seller told you about the property is true. This includes things like service/utility contracts, surveys, environments reports, rent rolls, covenants, restrictions, and many other aspects of the property. If something strange or wrong comes up in your inspection of the property, you have the right to tell escrow to cancel the transfer of funds.