Five Mistakes Would-Be Buyers Make

When it comes to buying commercial real estate there is invariably often five mistakes that many would-be buyers make.

 

1-   Overly obsessive on yield:  Too focused on a getting a certain level of yield or cap rate.  I have seen buyers turn down a great deal because they want a 6.5 yield when the seller won’t sell less than a 6.3 cap rate sale.  With perhaps a few exceptions, splitting hairs on a couple basis points is really ridiculous when it comes to commercial real estate (CRE)  Firstly, if you are buying a $10 million office building you would essentially be saying ‘getting $650k in income is great, but getting “only” $630k is a deal killer!’  Hate to tell you, but there are many other factors that are going to impact owners of CRE that are potentially going to cost a lot more than this $20k spread! Secondly, real estate is not like buying a municipal bond.  Each piece of real estate is a unique asset with a very unique set of attributes (location, design, demographics, tenancies, etc). Accordingly CRE can’t be so standardized.  This is not to say that an investor can’t have a minimum threshold of expected yield or that the cap rate shouldn’t be generally within market norms…I just suggest that the buyer not be so rigid that he loses sight of good opportunities due to being overly rate conscious.

 

2- watch out when making low ball offers if you have serious interest in the property. While there’s nothing wrong with trying to get the best deal you can, what invariably happens is that you won’t get a counter offer from the seller. Now you have put yourself in a box.  If you really wanted the property you have put yourself in a big disadvantage because you now have to submit another offer and in essence you are competing against yourself!   The seller knows it too. He will keep you guessing until you drive the price up on yourself.  Offering a 20 or 30% discount to the asking price of a seller is just going to aggravate the seller and convey that you aren’t a real buyer, just bottom fishing.  The exceptions to this scenario are if the seller has real financial difficulties or if the property is priced out-of-line to begin with.  If you want to try the low ball route, be prepared to walk from it, as it is a one shot game.

 

3- Not paying attention to the details.  Many properties today are doing quite well, with occupancy being very strong or maybe even 100%.  The seller will usually try to sell the property based on a cap rate of their full occupancy or a “performa” income.  In the real world there are virtually no income properties with zero vacancy for long…you have to adjust your expectations that this 100% leased 7 cap asset is really a 6.5 cap asset once you factor in a vacancy factor (as well as transaction costs).  Other factors to consider include rental rates compared to the overall market, roll-down risks, future capital costs for replacement tenants, etc.    Many brokers and buyers seem to overlook these risks so proper underwriting is key.

 

4-  Failing to deal in strength.   If you are going to play in the CRE world, play with strength and conviction or don’t play at all.   For example, don’t bother presenting a $10 million offer with only a $10k deposit and a “free look” for 120 days, plus financing contingencies.  Sellers can smell a unqualified buyer.   Sellers look at three things in an offer: price, strength of terms (deposits and timing), and the probability of the deal actually making it to the closing table.  If you don’t have the strength of terms, it will convey that your deal may have a low probability of ever closing.

 

5- Not taking advantage of local knowledge.  Every market is different.  Build a team of professionals (real estate broker, attorney, engineer/planner).  There’s nothing that can replace solid local knowledge when it comes to understanding the long term trends, zoning issues, and market values and rates. Things in SW Florida are not the same as in New Jersey or Cleveland. It will be well worth the fees involved.

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