Commercial real estate has the potential to reward investors with outstanding returns. But, commercial deals tend to be far more complicated than their residential counterparts. For instance, a commercial transaction normally has more stakeholders involved than a residential deal would. Real estate investors need to understand the roles and responsibilities of these stakeholders to analyze potential deals. As such, we’ll use this article to outline the key players in a commercial real estate deal.
Specifically, we’ll cover the following topics:
- Core Players in Commercial Real Estate Deals
- Additional Players in Value-Add Deals
- Additional Players in New Developments
- Final Thoughts
Core Players in Commercial Real Estate Deals
Every commercial real estate deal has its own unique characteristics. And, each separate deal requires its own unique combination of personnel to make happen. But, regardless of deal type, certain key players will be necessary across the commercial real estate spectrum. In this section, we’ll provide a brief overview of those core personnel – the people you’ll be working with in any deal.
Similar to their residential counterparts, commercial real estate (CRE) brokers help investors find deals. Both types of brokers start with the same license. However, commercial ones must understand far more about property tax and municipal zoning laws, financial analysis, commercial tenant property management, and the commercial appraisal process.
Additionally, if you need to buy a home, multiple online resources (Zillow, Redfin, etc.) exist to help you on your search. While you can find commercial deals online, many are not widely published. Working with a local CRE broker allows you to find the available deals that fit your investment objectives. Related to this, a broad variety of commercial property types exist (e.g. multifamily, office, industrial, etc.). Working with a CRE broker who specializes in a particular property type will help you find and assess far more deals than you likely could on your own.
Lastly, like residential brokers, CRE brokers serve as your advocates in a transaction. With their in-depth knowledge of local market conditions, they’ll help you negotiate the best possible terms in a deal.
When you purchase a home, due diligence calls for a home inspection. With a commercial property, the stakes are far higher, and the building’s frequently far larger. As a result, prior to closing on any deal, you should hire a structural engineer to inspect the building, typically via what’s known as a commercial property assessment. When you pour significant amounts of capital into a deal, you’ll want to first confirm the structural integrity of the building to protect your investment.
Depending on deal type, you may need some form of short-term financing (which we’ll discuss in the next section). But, for any commercial real estate you’ll plan on holding, you’ll need a lender to provide a long-term mortgage, often referred to as a permanent lender.
Technically speaking, you can undertake an all-equity deal. However, this A) poses significant capital challenges, and B) eliminates the amplifying returns of using debt to finance a deal. Having a relationship with a reliable permanent lender will ensure you receive the best possible loan terms and have a clear understanding of the requirements to close a particular loan.
Alternatively, you can establish a relationship with a commercial mortgage broker. These individuals don’t represent a single lender. Instead, they pitch your deal to a variety of lenders, helping you to get the best available deal – regardless of lender. Of note, brokers charge a fee for their services normally paid by the borrower.
Limited Partners / Investors
Generally speaking, commercial real estate costs far more than residential. For many potential investors, these capital requirements prove a major obstacle to making a deal happen. That is, you may have the experience to underwrite and execute a deal, but you don’t have the capital. For example, say you can purchase a stabilized apartment building for $10 million. At 80% loan-to-value, that translates to $2 million down payment – a lot of money.
Many deals are structured with a sponsor (or general partner) who finds and executes the deal, and investors (or limited partners) who provide the funds and receive a return on capital. In this situation, the sponsor may provide $200,000 of the capital, and investors could provide the other $1.8 million. In this fashion, you as the deal sponsor control a $10 million commercial property despite only contributing $200,000 of capital. Bottom line, outside investors often provide the capital necessary to take a deal from idea to reality.
Real Estate Attorney
As stated, commercial real estate deals prove far more complicated than residential ones. With the latter, buyers and sellers use boilerplate contracts, and they have the option to add additional clauses depending on the deal. With a commercial deal, every contract’s unique, and they tend to be fairly complicated – especially for new investors.
A seller’s attorney generally draws up the first draft of a sales contract before sending it to the buyer for review. While you can review the contract yourself, a real estate attorney working on your behalf will have the legal training and experience to thoroughly analyze this contract, ensuring you have the best possible terms. Typically, several iterations of the contract will go back-and-forth between seller and buyer before a final copy is signed by all parties.
CRE Settlement Agent
Due to the more complex nature of commercial deals, closing on those deals also tends to be more complicated. As with residential deals, a third-party settlement agent will facilitate this closing between buyer and seller. These agents generate the settlement statement that itemizes all seller and buyer contributions and credits. Prior to closing, settlement agents hold transaction-related funds in escrow. At closing, these agents facilitate the signing of all legal documents, transfer of funds, and required filing of official documents.
Broadly speaking, settlement agents act as neutral third parties to administer a transaction. In commercial real estate, a law firm specializing in commercial settlements typically fulfills the role of agent.
Normally, investors purchase commercial real estate to earn passive income – not to manage the day-to-day operations. If you don’t have the interest, time, or experience to manage a property, you’ll need to hire a property manager. Depending on the scale of the deal, this may be an on-site manager or a company hired to remotely handle management.
Regardless of system, property managers enable the day-to-day operations of a commercial property (e.g. finding, screening, and placing tenants, overseeing maintenance requirements, turning units when a tenant leaves, etc.). Yes, this expense will reduce a property’s net operating income. But, it also ensures that A) experienced professionals manage the property, and B) investors can focus on other pursuits – not the day-to-day needs of the property.
Additional Players in Value-Add Deals
You’ll normally find the above parties in all commercial real estate deals. But, when you add layers of complexity to a deal, you also increase your personnel requirements. In this section, we’ll discuss value-add deals. In these deals, investors purchase a property and conduct renovations and improvements to increase rents and, therefore, increase the property’s value. These deals include all of the above players plus the ones outlined here.
Most value-add deals include a remodeling of individual units. In theory, when you improve a space, you can charge a rent premium. For example, say you purchase an apartment building with “standard” appliances and design. An interior designer can help you develop a “silver,” “gold,” or “platinum” package for renovated units, each with incrementally nicer appliances and design.
Once again, someone with an eye for design could certainly do this personally. But, in a multi-million dollar commercial deal, hiring a professional to design these renovation packages normally makes sense.
A designer outlines the vision for a value-add project, but a general contractor (GC) turns that into reality. Any time you’re renovating (or completely constructing) a commercial property, you’ll need to work with licensed GC. This individual (or company) will supervise the actual renovation work, often by hiring and managing a team of subcontractors.
As stated above, any real estate you plan on holding for the long-term will require permanent financing. But, many value-add projects also require short-term financing, often a combined acquisition/renovation loan. These loans tend to be non-amortizing, interest-only financing for a limited period (one to three years). But, they allow investors to A) finance a purchase and renovation, and B) limit cash requirements due to their interest-only nature.
At the conclusion of the renovation period, the value of the property – as the name suggests – should have increased. Based on this increased value, investors then secure permanent financing, which, if the deal has been correctly underwritten, will pay off the short-term loan (and potentially return some cash to investors).
CRE Leasing Agent
If a value-add project includes renovations to any commercial spaces (as opposed to residential units in an apartment building), you’ll likely need to secure new commercial leases. In a recurring theme, a commercial lease proves far more complicated than a boilerplate residential one. Landlords often negotiate tenant improvement allowances, utility pass-throughs, rent escalations, and other topics not inherently familiar to all parties. And, due to the longer-term nature of most of these leases, the risks of a poorly negotiated contract are even higher.
A CRE leasing agent will help you find potential tenants, negotiate the best possible terms, and secure leases. While they charge a fee for this service – typically a percentage of the lease – the services normally more than justify this additional cost.
Additional Players in New Developments
New Development Overview
Completely new developments (i.e. transforming dirt and an idea into a stabilized property) are the most complicated commercial real estate transactions. Accordingly, you’ll still require the above players, but you’ll also need, at a minimum, the following two professionals for a successful deal.
Architects turn your idea for new construction into executable reality. Say, for instance, you want to build a 100-unit apartment complex. Anyone with some basic computer skills (or a camera) can show what they want that building to look like. But, only an architect is A) formally trained to design the plans for that building, and B) legally allowed to sign-off on those plans.
If your commercial deal involves construction, you’ll need an architect. However, working with one should be an iterative process, with you providing conceptual guidance and feedback on draft plans, and the architect working through a few versions to eventually finalize agreed-upon plans for a project.
Municipal Zoning Specialist
New developments also face another major obstacle: municipal zoning laws. Developers can’t just build whatever they want, wherever they want. Rather, local municipalities have detailed laws and maps outlining what zoning codes exist in what area. For instance, one block may be zoned for single-family residential homes only, while the next block allows commercial storefronts.
A municipal zoning specialist – frequently lawyers experienced in the local laws – help developers navigate these requirements. And, these attorneys also will petition on your behalf to rezone a given plot of land from one code to another.
For investors, understanding the key players in commercial real estate helps you analyze potential deals. And, if you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about available passive real estate investment opportunities.