As you have read here many times, buying commercial real estate is a great way to build generational wealth. It’s like the jelly of the month club. By that I mean the gift that keeps on giving!
Many people reading this column have set up a venture housed in a parcel of commercial real estate, which they also own. So, the occupant company earns income through its business operations and pays rent for the use of the building. The value of the company grows over time and the address appreciates. A double hit!
There are countless entrepreneurial stories in Southern California that took a generation to take a risk, built a company, bought a location, and benefited successful family members. I have had the privilege of consulting these family owned and operated manufacturing and logistics businesses.
Recently, one conversation struck me as particularly column-worthy. Specifically, how much should be allocated for the down payment when considering a purchase? The easy answer is 10% of the purchase price if leveraged through the Small Business Administration and 20-30% if financed traditionally. Boom. What happened. See you next week.
But, wait, there’s more… There’s more to the loan origin story. So, please stay a minute longer.
In addition to 10-30%, a budget would be suggested for the following:
Evaluation: Regardless of your lender choice — SBA, bank, insurance company, or hard money — an appraisal will be completed. A confirmation within the bank’s underwriting that the price paid is in line with the market. Plan on $2,500-$5,000 for this review.
Environment: Hiding beneath the surface of your shopping can be a problem. These overlooked issues are caused by something toxic deposited in the soil. Reviews of past occupants in the building, messy neighbors, and a plume of smoke down the street—combined with a look at old aerial photographs—are known as a Phase I environmental report.
Usually, this does the trick and provides a clean bill of health. If environmental concerns rise – such as stained concrete or waste containers – a phase two will be employed. Soil boring is sampled and tested. Recommendations range from no further action to remedial.
Have you ever noticed a pile of dirt inside the yellow tape next to the gas pump at your local station? No, this is not a case of CSI. One way to get the bad stuff out of the soil is through aeration. Plan for $2,500 for later stages if treatment is needed.
Legal: You will want an attorney to review the purchase agreement, title commitment, and prepare your LLC formation documents. Budget around $10,000.
Escrow and Title: Sure, the seller pays for a standard policy, but any lender policies or extended coverage will cost you. Plus, you’ll pay half of the escrow fee. Another $10,000, but it depends on the size of the deal.
Survey: This isn’t always necessary unless you’re after an extended policy of title insurance. Unrestricted access, abandoned driveways and recorded leases are generally not covered with a standard policy. Utility locations, property lines and underground pipes are also clearly mapped. $5000 is reasonable.
Loan Points: In addition to the interest payments due during the term of your loan, you will pay a percentage of your loan amount to the bank. 1-2% is very typical.
Cost Separation: One of the really cool things about owning commercial real estate is the depreciation that lowers your income tax burden. The better parts of your parcel – the buildings – can be depreciated on a straight line over 39 years – 1/39th of each year. But other components of improvement such as walls, doors, glass and air conditioning have a shorter useful life, and if properly disassembled, can wear out sooner. Usually, your CPA can help with this. However, she would like to pay. $15,000 seems reasonable.
Once you become the owner, collect and total your receipts. Add 10-30% of what you spent to the down payment. What is the result of a “true” investment in your purchase.
Alan C. Buchanan is principal of Lee & Associates Commercial Real Estate Services in SIOR, Orange. He can be contacted at [email protected] or 714.564.7104.