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Dear Monty column: How to invest in commercial real estate

7:28 PM, May 9, 2013  |  Comments
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Q. I currently own a commercial building. The mortgage was paid off when I inherited it. I am looking for a profitable long-term investment. I would like to leverage my building to buy another one. How do I find a great deal? How do I calculate return? What formulas are important to find an appropriate cost? - Simon B.

A. Hello Simon, thanks for your questions. While some speakers and authors claim anyone can make money in real estate, my experience dealing with consumers has shown it is not for everyone. A critical self-analysis on your strengths and weaknesses, life experiences and the amount of time available to dedicate to the effort is a good first step. Reading landmark material such as Dr. James Graaskamp's work at the University of Wisconsin, who have graciously granted their permission (bit.ly/16jPuIZ) is the second step.

When choosing a book, be careful of hucksters giving misguided or poor advice. If they are selling "no money down" or live courses in exotic locations, be very careful.

Finding a great deal is one of the key ingredients to success. It requires an understanding of the dynamics of the general location in which you are seeking to invest. Are property values declining, stable or increasing? This data and more are important because even with the ability to make a wise purchase, if the general conditions in the neighborhood are going south, a good buy may not be enough. In fact, the seller knowing more about the neighborhood than you may be the reason the "good buy" is available.

Next, focus on determining a property's range of value. This is part of the "formula" in determining the cost. Become an expert in valuing property before making your first purchase. The key is to understand the process appraisers follow. Consider taking an appraisal course or reading another book about appraising property - a publication from the Society of Real Estate Appraisers or the Urban Land Institute. Studying and understanding the market and knowing how to evaluate the property before investing is an important step.

A source for reliable information on commercial properties is important. Commercial brokers do not usually participate in a multiple listing service. If your city is large enough, there are many commercial real estate brokers who disseminate market information on different segments in the commercial space. In smaller cities, the brokers who specialize in commercial real estate know what activity is taking place. This information is necessary to answer questions about the market and appraise property. If you have time, the local register of deeds office compiles public records on completed property transfers. Otherwise, driving neighborhoods looking for signs, checking newspaper ads or websites to gather information is another option. You need a method to identify new properties that fit your investment criteria as they come up for sale.

Many financial experts and accountants have different methods for determining the rate of return on a real estate investment. Download templates in Excel format from garytharp.com/forms. These forms are a valid method for approaching the financial fundamentals in a number of ways. The Urban Land Institute has additional material and guidance. I have used the APOD templates to evaluate property returns for many years.

Real estate investing includes a variety of choices. Commercial examples include office buildings, industrial buildings, apartments, vacant land, sale-leasebacks, storage facilities and retail buildings. The greater the risk, the more you should expect in return. For example, most lenders consider vacant land development as one of the riskiest real estate ventures. Understanding the market may help determine which category offers the best opportunity. Specialization will help create an expert sooner than becoming a generalist.

Find your niche. The tactics and knowledge necessary can be a stark contrast. As an example, flipping houses is much different from adding value to a vacant lot through re-zoning. Real estate is not normally a short-term investment.

Real estate has never been considered a liquid investment like a publicly traded stock, but the past five years have effectively demonstrated that real estate can be quite liquid - it is simply a matter of price.

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