When attempting something new on your own, it’s almost a guarantee that you’ll make some mistakes. Commercial real estate investing is a complicated and nuanced art to get right. It takes time to learn the ins and outs. When first investing, you’ll quickly come face to face with the consequences of a bad investment decision.
Though far from the end of the world, a poor investment choice can dishearten even a seasoned investor. This post will help new investors avoid some of the pitfalls that can befall anyone who first steps foot in the space.
Though mistakes can be valuable lessons, you don’t always have to experience one first-hand to avoid them in the future.
Common Commercial Real Estate Investing Mistakes
Before digging into the mistakes, it’s essential to discuss the virtues of discipline and patience when first engaging in the space. When devising an investment strategy, you’ll need to do your due diligence when selecting your investment opportunities. You need to have discipline upfront because you often won’t know the implications of your decisions until much later on.
This brings up the second point. Investing in commercial real estate is a long-term game and thus requires a long-term mindset. Now that we’ve discussed these two virtues, we can start examining the mistakes you’ll want to avoid as a new commercial real estate investor.
Not Devising an Investment Strategy
There is an old saying that “prior preparation prevents poor performance.” These five Ps are generally useful, but they are especially prescient for commercial real estate investing.
If you don’t have a plan, you are dooming your investment to failure. You can’t simply throw money at something and expect everything to work out by itself. Usually, investment plans consider the following attributes:
Property Classification
What type of property do you want to specialize in? A grocery store property operates quite differently than a storage warehouse. Many real estate investment firms specialize in one or a few similar property types because of all the variations that need to be accounted for between different classifications.
Generally, investors make more mistakes when they invest in unfamiliar properties. This is because each property type has its own quirks and idiosyncrasies. Investors perform best when they are familiar with the territory.
Property Size
The larger and more complex the property, the more potential for error. This is due to not only size but the increasing factor of managing tenants—the more space for retail, the more leases you need to be signed to stay afloat.
A real estate investor who is used to managing a few freestanding retail properties would be tasked with quite the upgrade if they suddenly needed to manage a shopping mall. Early investors should be wary of biting off more than they can chew.
Local Real Estate Market Conditions
Before investing, a commercial real estate investor needs to understand the ins and outs of the local real estate market. What factors are driving growth? What factors are preventing growth?
They need to understand local conditions, but they need to be able to see how a local market is functioning compared to other markets. How are grocery store properties in Sacramento performing against the same type of grocery store properties in Seattle?
Young investors will want to be wary of investing in local markets they are not familiar with.
Holding Period and Expected ROI
Investors need to know how long they plan to hold onto the property and how much they expect to make while doing so. Many commercial properties have a holding period as short as three years or as long as ten (or more).
If a novice investor doesn’t devise an appropriate holding period and plot their ROI for that duration, they could pull out of an investment before seeing the returns they could have if they planned better.
Not Performing Due Diligence
Ideally, there are four main types of due diligence a real estate investor needs to complete before making a purchase. Due diligence is necessary because performing it protects the investor from purchasing a property that is somehow damaged, dangerous, or otherwise compromised.
Performing due diligence can help determine whether or not the property is a mistake to invest in, which can save an investor several years and a large portion of their investment capital.
Physical Due Diligence
This refers to the act of thoroughly inspecting the property for any damage. This step is crucial for determining what repairs may need to be made while under your management. It can also help you identify any hidden costly damage—like structural damage.
Legal Due Diligence
This refers to making sure no legal hangups are threatening the process of a successful title transfer. This could involve a close inspection of current tenant leases as well as investigating other contracts that the current titleholder has with contractors for the property.
Environmental Due Diligence
Investors need to complete environmental due diligence to ensure there aren’t hazardous materials buried on-site. Usually, this requires an environmental site assessment to discover whether or not there are contaminants present on the property.
Avoiding the Help of Others
Novice investors might think they can handle all of the tasks required to successfully invest in commercial real estate, but this would be a mistake.
Here is a list (not at all comprehensive) of all the tasks a property investor needs to consider:
- Finding, assessing, and comparing investment opportunities
- Preparing legal documents—drafting leases, and other contracts
- Maintaining a property’s facilities and grounds once purchased
- Maintaining and managing tenant relationships
- Performing financial analysis and projects on ROI
- Advertising their commercial space to potential tenants
And this is just one property! Imagine balancing these tasks across several properties. It’s necessary to delegate specific tasks to others, whether through hiring a lawyer, consulting with risk analysts, or working through a third-party property management firm.
Avoiding the help of others is a great way to prevent becoming stretched too thin and making mistakes.
Not Formulating an Exit Strategy
Eyes on the prize, they say. A common mistake rookie investors make is not having a plan for exiting their investments. Their exit strategy needs to be formulated before the purchase of the property is completed. Investors need to have a clear ROI target where they know they have achieved their investment goals within their time horizon.
Avoid These Commercial Real Estate Investing Mistakes
There is no way around it—investing in commercial real estate as a beginner is scary. However, successful investors are made, not born. The only way to become a professional is to take measured, well-researched risks. Hopefully, the mistakes listed above will be easier to avoid now that you’ve read this article.
Roni Davis is a writer, blogger, content strategist, and legal assistant operating out of the greater Philadelphia area. She writes for Todd Mosser, a criminal appeals attorney in Pittsburgh, PA.Edit