Commercial real estate can be a lucrative enterprise, generating large sums of cash for the investor. It can also be a huge headache brought on by delinquent tenants, malfunctioning boilers and liability lawsuits. Sometimes it is both; sometimes, neither. Before diving into this tempting field of endeavor, new investors do well to understand what commercial property is. Strictly speaking, it is real estate that generates income as opposed to serving as a primary or secondary residence. That said, some commercial properties are owner-occupied, serving both purposes. Examples include apartment buildings, office complexes, farms and retail space.
Those who evaluate commercial buildings—mortgage lenders, tax assessors, appraisers etc.—seek to determine if the property pays for itself while having money left over. The funds required for a building to pay for itself include loan principal, interest, property taxes and insurance. Regular maintenance costs and other obligations detailed in leases are included, as well. For a bank or finance company, the mortgage monthly principal and interest are the expenses they want paid first. Accordingly, they will calculate the income from rents, business profits and other fees against the monthly mortgage payment (including taxes and insurance) to see if the income will be satisfactory to make the monthly payments over the life of the loan.
Commercial units generate money through monthly rents so the rents must be high enough to meet the debt service and other business costs. They should also provide an acceptable profit for the landlord. To accomplish this, owners must determine the average vacancy rate. If a number of units are consistently unoccupied, the cost of those vacancies may have to be passed on to existing tenants. Other sources of cash are parking spaces which—depending on geography—can supplement rents at apartment and office buildings. The landlord must secure this income by verifying the income of the tenants. Of course, the mortgage lender often requires this as a condition of any loan.
Acquiring the funds necessary to cover the debt service, maintenance and other expenses—not to mention an adequate income for the owner—requires leases that maximize rents and minimize landlord obligations. For example, maintenance costs can be offset by adequate security and pet deposits from the tenants. Rent increases, while necessary, should not price dependable tenants out of the building. In this way, investors can ensure maximum occupancy at minimal cost, the key to commercial real estate success.