Commercial Real Estate Deal Start to Finish

Discover what a commercial real estate deal looks like from start to finish. I’ll begin with identifying a potential commercial investment and then walk you step by step through initial deal analysis, making an offer, due diligence, financing/fund raising, closing, adding value, managing and finally exiting or refinancing. These are the 10 steps, start to finish, of what any commercial deal looks like:

 

3 Key Factors to Consider

Before you discover the details of these 10 start to finish steps, there are 3 things to keep in mind about commercial real estate transactions.
1. Commercial Transactions Take Time: A commercial real estate transactions can take 60 to 90 days to complete. When you purchase a residential property, it can be done in 30 days or less. But with commercial real estate, the entire process can be double or triple the length of a residential deal.
2. Apply to Every Commercial Deal: These same 10 steps apply to every type of commercial property, whether it is an apartment building, self storage facility, mobile home park or any other commercial real estate. It also applies to every sized deal, whether a 5 unit or a 500 unit.
3. No Degree Required: To be successful in commercial real estate, you don’t need a college degree. In fact, one of our Proteges, a truck driver and awesome guy with no previous commercial real estate experience, recently acquired an 18 unit multi family apartment building. It was his very first deal! He simply followed these 10 steps from start to finish and you can do it too!
 

Step 1: Identify Potential Commercial Investment

While most commercial purchases are first identified by a commercial real estate broker, we prefer to focus on off-market properties so that we can connect directly with the Seller. You can obtain the best deals and structure creative financing much easier from off-market properties. It is possible to find a good deal from a Broker that has a pocket listing too and that starts with Choosing the Right Commercial Real Estate Broker. Whether off-market or through a broker, the first step is to identify a suitable commercial property.

Step 2: Initial Deal Analysis

Analyzing and evaluating the deal and the market can be complicated and challenging for beginners. You’ll need to calculate the Most Important Commercial Real Estate Metrics including net operating income, cash on cash return, cap rate, debt coverage ratio, building class and much more, both actual and pro forma. Our Proteges get access to software that helps calculate these important metrics and much more to better analyze deals.
In addition to the property itself, you’ll also need to analyze the market to which the property is located and study the sales and rental comps along with the market cap rates.
And this initial analysis will be done all over again once your offer is accepted but you need to establish this first analysis in order to make an offer.

Step 3: Make an Offer

Armed with the knowledge you gained from your initial deal analysis, you can now formulate and submit an offer with either a letter of intent or a purchase contract. A letter of intent includes the basic terms of your offer, such as the purchase price, your down payment and financing, as well as a closing date. A letter of intent is not legally binding but it does allow you to get your offer in the hands of the seller quickly.

A far better way to make an offer is to complete Step 2 correctly and make a binding offer with a purchase contract. Some beginners fear using a purchase contract because it locks them into certain contractual commitments but wise commercial investors (like those that we mentor) have contingencies for things like inspections, financing, title, appraisals and surveys so that they can get out of a bad deal if they need to. Also, many do not have access to a well crafted purchase agreement and even if they did, those same prospective investor wouldn’t understand each of the clauses in a good purchase contract even if they had one. Some rely on real estate brokers to handle purchase contracts but ultimately, since the broker is not the one signing on the dotted line, you as the buyer need to understand every aspect of the document you are signing.

Furthermore, most sellers do not agree to your initial offer so it takes skill to negotiate effectively with a Seller to structure a deal that works for both you and for the seller. This is another example of where having an advisor coaching you through the process is to critical. You don’t get a second chance to negotiate your first offer with a Seller.

Step 4: Due Diligence

If your negotiations with a Seller have culminated into a signed contract, while some celebrate, experienced commercial investors know that there is a long way to go before the deal is done. In fact, a new pressure begins because you enter the “Due Diligence Period” which is a short time clock to complete your review of the property or else you risk losing your earnest money and/or being forced to buy a property you no longer want. Although it can be negotiated differently, usually on a commercial deal, you are given 30 days for due diligence.

This is the part where you test every assumption you made when you agreed to purchase the property because you can’t rely on anything the Seller has told you. You must verify, verify, verify. In commercial real estate, there are very few (if any) laws that protect you from a lying Seller. The risk is on you as the buyer so it’s Caveat Emptor (buyer beware)! Again, this is another example of where having a coach/mentor is an invaluable asset to a commercial real estate investor.

Your due diligence is broken up into three areas: physical, legal and financial:

Physical Inspection: The physical inspection includes reviewing the property, in person, with a professional inspector as well as your property manager [here is some wisdom on Hiring (and Firing) a Commercial Property Manager]. You also may need to take an electrician, a plumber, a roofer, and/or structural engineer with you. Everybody will be there on one day or over a few days to conduct this very thorough physical inspection. For a detailed training on apartment inspections, here’s How to Inspect an Apartment Building. This part is complete lwhen you have an inspection report as well as repair estimates from the various contractors

Legal Inspection: The legal inspection involves the title to the property as well as zoning and other land use details. Your title company or closing attorney handles the title search but you may need another land use attorney to ensure that the property has the legal right to the number of units and the use to which the seller has been operating. Sometimes, Sellers illegally rent too many units or the wrong use but get away with it because no one complained. You need to make 100% sure that you can continue (or expand) the use the Seller has been doing.

Financial Inspection: The financial aspect of your due diligence includes examining the actual income and expenses on the property, as shown by tax filings or rent rolls along with utility bills and any other evidence that you can get from the seller. In some instances, especially with really good deals, the seller provides precious few details and you are left to make determinations without any evidence. Here is yet another example of where a very experienced mentor can fill in the financial gaps left by a disorganized or lying Seller. A deep analysis of accurate financial information is essential to being able to make an intelligent decision to invest in a commercial property. This is not gambling. This is disciplined investing whereby you let the numbers lead you, not your feelings.
If creative financing is not involved and therefore you must originate commercial financing, the other incredibly important aspect of the financial inspection is applying for the loan. You may apply to several lenders to shop for the best funding and it can take every bit of the due diligence period to get an answer back as to whether or not the property and/or you qualify for the loan.

And all of that due diligence must be completed before your contingency period expires! If you have conducted your due diligence thoroughly and completely, you are ready for the next step.

Step 5: Decision

Almost always, your due diligence uncovers problems that you didn’t anticipate when you first made your offer. Therefore, this is where you attempt to renegotiate with the Seller by submitting a counteroffer. Oftentimes, commercial investors ask for either a seller credit, repairs to be completed prior to closing or a price drop.

If you are getting a loan, the lender may also have expressed some concerns with financing the property either due to the condition, financials or the appraisal. Or perhaps the financing terms may be worse than you had hoped? Recently, Cap Rates have been Lower than Interest Rates, making it even more difficult to make the numbers fit into an investor’s requirements. Any issues related to the financing creates a great opportunity to renegotiate with Creative Financing.

After your renegotiation, you now have to make the hard decision as to whether or not you are going to buy the property. Here are the 5 Keys to Making Decisions in Commercial Real Estate. Obviously, having a very experienced trusted advisor can be extremely helpful in you making the right decision. However, a real estate broker cannot be a trust advisor at this step because the broker is financially incentivized to persuade you to move forward with the deal and only gets paid if you buy.

From a contractual perspective, this is where you are either going to confirm the expiration of the contingencies or you are going to cancel the contract based on those contingencies.

Step 6: Closing Preparation

Now that you have decided to move forward with the deal, you need to prepare for closing the deal, which involves finalizing several details:

1. Finish Fund Raising / Syndication: If you are raising private money to fund the down payment or renovations, you’d finalize that here.
2. Clear Loan Conditions: Clearing loan conditions is big in commercial real estate. Once the lender approves your deal, they send you a long list of “stips” or the requirements things that you must supply them to get the final approval and get the deal closed.
3. Finalize Property Management Agreement: Many of our students don’t manage their property themselves but will hire a property management company.
4. Create Operating Budget: The operating budget is what you’re projecting for the next 12 months based on the monthly income and expenses. This is a must. You can’t just buy a commercial property and expect cash flow. You need to be intentional about what income is coming in, and what expenses you are paying out to manage the property and pay the mortgage so that you have some cash flow left over.
5. Create CapEx Schedule: CapEx is capital expenditures. They are generally one-time items like replacing a roof, replacing HVACs, fixing a parking lot, or tearing down and re-building new stairwells in the property. To have a working operating budget you will need to figure Cap Ex items into it.
6. Finalize Asset Management Plan: The asset management plan is a document we created for our Protégé Program. It helps mentees set benchmarks for how they’re going to operate the property from day one all the way through to their exit strategy. When it is complete, the asset management plan will include the budget, the CapEx, day one cash flow, day 30 cash flow, and any safety expenses. This plan is critical to making sure that you know what you’re doing, so you can be successful.
7. Entity Formation: This is also the point when you would may form a new entity to own this new property. This is also where you will formalize your syndication documents if this is a Syndication Deal.

Step 7: Closing

The closing is the simplest step of the process. After you wire the final proceeds to the title company or closing attorney, you’ll either attend the closing in person or through a mobile notary and sign a thick stack of legal documents. It is very important that you understand what you are signing so take your time and ask questions if you are confused.

And then comes the celebration! Be grateful and do something nice for yourself. Personally, I like to treat myself to a steak dinner after closing a deal. I love a Japanese delicacy called Wagyu steak. It’s so delicious, and its expensive, but I deserve it after doing all this work, and you will too. So do something nice for yourself.

Step 8: Asset Management

As one door closes, another one opens. Now that the deal has closed, an entirely new objective commences which is referred to as asset management. Asset Management includes improving the property management as well as the property itself in order to maximize the Net Operating Income (NOI) and therefore the property’s value and its cash flow. To learn more about how property improvements add tremendous value, here’s a specific example on How to Make Big Bucks with Value-Add Commercial Real Estate.

Property Improvement: The property improvement plan would have already been established prior to closing so at this point, it would simply commence. What this oftentimes looks like is that as units are vacated, the contractors renovate and then the property manager can then re-lease for a higher monthly rate. In other instances, it may involve building on more units to an existing building.

Your role as the investor in this step is to be the air traffic controller, coordinating with the property manager and the contractors to ensure everything is accomplished according to plan. You want to be militant in directing traffic because otherwise, the other participants will cut corners, make unilateral decisions and wreck havoc with your plans. There will be delays and challenges along the way, but if you stay diligent and lead your people wisely, you’ll be surprised by how much can be accomplished.

Improve Property Management: In addition to adding value through improvements, there will most likely be plenty of room to improve the management of the property. Even though hiring a really good property manager is important, as the owner, you still need to manage the manager. This is where you implement ways to improve performance, such as adding a laundry facility to an apartment building or upgrading the software to which the units are managed (which we often do with self storage facilities). As mentors, we have added tremendous income to our Proteges properties by suggesting small management improvements that have huge financial impacts.

With the property and the management undergoing improvement, now comes the most boring step…

Step 9: Proper Bookkeeping

This step is absolutely essential to optimizing the performance of any commercial property and its unfortunately rarely, if ever, mentioned in the commercial real estate investing education world. Properly accounting for all income and expenses is a mandatory part of being a successful commercial investor. Through our program, our Proteges get access to the very best commercial real estate bookkeeping services at the lowest cost in the industry because we know just how vital this component truly is.

With the proper bookkeeping, you can monitor the Four M’s of commercial real estate ownership: Management, Money, Marketing and Maintenance. Like the 4 legs of a stool, if any one of those four M’s is off, the entire property will fall.

Proper bookkeeping also allows you to take full advantage of all the incredible tax benefits of commercial real estate investment. Here’s How to Reduce Taxes with Commercial Real Estate.

Step 10: Execute Your Exit Strategy

Once you have optimized the performance of the commercial property, you have reached the final step of executing your exit strategy. There are basically 2 exit strategies that commercial investors employ:

1. Cash Out Refinance & Hold: For most people, owning a commercial property long term to enjoy the monthly cash flow (and the freedom that it buys you) is the primary exit strategy. Since you invested in improving the property, structuring a cash out refinance typically makes financial sense because your initial investment can be returned to you and you still get to keep the property. This concept is highlighted in the video Have Your Cake and Eat it Too. What a cash out refinance also allows you to do is purchase additional commercial real estate because the proceeds from the loan are not taxable gains. Some have labeled this process with the acronym BRRRR (Buy, Renovate, Rent, Refinance, Repeat).

2. Sell: Not everyone wants to stay married to their commercial property, perhaps because it’s not performing as well as they had hoped or maybe that particular market is peaking and they want to cash out while times are good. If the goal is to continue to invest in commercial real estate with the sale proceeds, most commercial investors sell into a 1031 exchange so that they can defer any tax ramifications of the sale. While we strongly recommend doing a 1031 exchange if you are selling, what some have done is sell, pay the tax liability and then use the remaining proceeds for something entirely different than real estate. Either way, the choice is up to you.
 

Those are the 10 steps, start to finish, of a commercial real estate deal. After going through them, can you see yourself investing in commercial estate? At Commercial Property Advisors we can guide you through every step of commercial real estate investing. Learn more about our Protégé Program here: https://www.commercialpropertyadvisors.com/protege-program/