Commercial real estate: How to plan your purchase
Buying real estate for your business is an exciting milestone for any entrepreneur. It signifies that the company is poised for growth and financially prepared to invest in a long-term location.
However, a commercial real estate acquisition can be complex. It requires diligence, rock-solid financials and forecasts, and a well-thought-out plan.
Nadia Amaral, Senior Account Manager at BDC, advises her clients to gather a team and take the time to ensure a successful transaction.
“You need a plan to successfully execute a commercial real estate acquisition. Entrepreneurs should consider sitting down with a banker, an accountant and a lawyer to ensure they’re fully prepared for the transaction. It’s helpful to start planning 12 to 18 months in advance.”
What is commercial real estate?
Commercial real estate is property or buildings from which a company can operate a business. It is designated by law and is usually zoned for commercial, industrial or mixed-use purposes.
Why invest in commercial real estate?
When starting out, most entrepreneurs rent or lease their office space, storefront, warehouse or manufacturing facility. “It often makes more sense to do that while focusing on establishing the business,” Amaral says.
However, if you find yourself making a lot of improvements to the rental property to retrofit it to your needs, or the space is inhibiting your business’s growth, it might be time to consider putting the lease or rent payment towards a mortgage for a building you will own.
Mortgage payments amortized over 20-25 years are often smaller than monthly rents or annual leases. “Switching over can free up working capital and support business growth by using those funds to hire employees or invest in operational equipment or efficiencies,” Amaral says.
Owning commercial property can also mean a business takes on less risk and acquires more stability—they are not vulnerable to a landlord’s whims or a change of ownership.
“Opportunities sometimes present themselves to our clients when the building they rent, or the one next door, is up for sale. Maybe they weren’t considering purchasing, but it becomes something they decide to do,” Amaral says.
“In many cases, entrepreneurs who are renting or leasing have the right of first refusal when the building they’re in goes up for sale. It’s worth going through the exercise of assessing the risks and rewards because it may be the right decision for long-term success.”
What do you need to know before buying commercial property?
When looking at purchasing property, an entrepreneur should take into account all costs and considerations:
How was the price established?
Amaral lays out some important questions to ask yourself:
- How was the price established?
- How does it compare to similar properties in the area?
- Has an Accredited Appraiser Canadian Institute (AACI) appraisal been completed?
A qualified realtor will be able to make the market comparisons to ensure the property is priced fairly for the current conditions, but it’s useful to go online and do your own search of comparable buildings in the area. If an AACI appraisal hasn’t been provided, it would be in your best interests to have one conducted.
What is the condition of the building?
If a baking business buys a building that was formerly a bakery and is still in good condition, it can move in and start operations right away. But that’s not often the case, says Amaral. The cost of acquisition may include renovation.
“It’s important to determine what kind of work is required, both cosmetically and structurally. Does it need a different layout? Paint? Electrical? Flooring? What’s the condition of the roof and the HVAC?”
If extensive renovations are required, it’s useful to have a contractor provide a quote that can be factored into the price of the purchase. The contractor can put together a budget and your accountant can prepare a cash flow forecast to help you understand what your financials will look like for the first year or two after you move in.
“We see a lot of clients who purchase a property and then have to invest another $30,000, $50,000, even $100,000 in renovations. Lenders will consider this as part of the financing package but it’s best to have a plan at the outset,” she says.
Are there recurring costs?
Try to get the full picture of what you’ll be required to pay on a regular basis, including:
- property taxes
- maintenance (e.g., snow removal, landscaping)
“You need to do your due diligence on all the costs associated with owning a new space,” Amaral says.
How much will it cost to move?
It can be costly to pack up your operations and move them to a new property. Consider what that process would look like and budget accordingly.
“You also have to factor in any operational downtime that may be required during renovations and relocation,” Amaral says.
Risks and benefits of a new location
If you’re thinking of moving your operations to a new area, you’ll need to consider the impact of the location, the previous operations and the buildings and commercial operations that surround it.
“How does this new location benefit your company moving forward? Is it in a higher or lower traffic area? Will it be easier or more difficult to receive shipments? Think about all the ways things will be different than your original location,” Amaral says.
She cautions entrepreneurs to also account for environmental factors. “Most lenders require an environmental assessment on every building they put a loan on. You want to know what was there before to understand any risks or costs associated with potential environmental impacts”
How do commercial real estate loans work?
Commercial real estate loans are funds that a lender is looking to secure against land and buildings. These loans are often called commercial mortgages. Before approving a commercial real estate loan, lenders need to establish the value of a property, usually from the cost, a recent AACI appraisal or municipal assessment.
Loan terms are typically amortized over 20-25 years. After analyzing the financial statements of the borrower (usually the company that will operate from the premises), a lender will need to establish how they will pay back the loan.
“We typically look at a business’s cash flow to determine how much they can afford. An accountant can help you answer what you can afford today and in the future,” Amaral says.
It can also be helpful to bring a lender into the early conversations with your accountant once you have financials in place. They can advise on what’s feasible based on current numbers, including amortization terms and interest rates. This can support your search for the right property.
Explore what lenders can offer your business
Amaral says that it’s important to explore what lenders have to offer your business. They should come to the table with choices and information about grants, potentially cheaper loans and government programs that may be able to help entrepreneurs with acquisitions.
“Our role as lenders is to know what’s out there so we can provide trusted advice to entrepreneurs. For example, grants that can be used to pay down loans or to support future growth. Depending on the project, we build them into the overall lending,” she says. For instance, many programs can help finance the type of retrofit that will lower a building’s energy use.
If you’re a seasonal business, you can also ask lenders about alternatives to monthly payments. These can offer more flexibility and take into account the varying levels of cash flow in businesses with busy and slow seasons.
Another thing to inquire about is the ability to postpone payments as you ramp up in the new location. “A financing project could include terms that postpone principal payments for up to 12 months as part of the original ask. It’s not unusual, nor are prepayment options up to 15% every 12 months, which allow entrepreneurs to fast-track repayment,” Amaral says.
Her biggest piece of advice when it comes to finding a lender is to approach them early on in the process, as they have their own due diligence process which can take six to eight weeks.
“Don’t wait till the last minute to go to a lender. Engage them early and often so the process can be smooth from start to finish.”
How do interest rates affect commercial real estate?
Rising costs in the economy can make borrowing money more expensive. Mortgage payments will be higher when interest rates are higher. It’s important to have an accountant make a thorough assessment of your financials to understand what is affordable for your business at the moment—and in future market conditions.
When it comes to interest rates, Amaral says the biggest decision for anyone getting financing for a real estate acquisition is whether to choose a fixed or variable rate.
“We are asked a lot whether an entrepreneur should fix or float and the answer is, ‘It depends on your risk tolerance.’ You can choose to fix at today’s rate and, in the next couple of months, interest rates could drop and you’re stuck with higher interest. Or, vice versa, rates can continue to rise when you’ve locked in at a better rate. .
“Some entrepreneurs may choose to float and ride it out and will have to navigate a fluctuating mortgage payment. Recently, we’ve seen that rates can jump tremendously and affect many businesses’ ability to operate and potentially grow because they’re making larger mortgage payments. It’s another reminder that having a plan that makes sense to you and your business can help navigate rates in the current economy.”
Reviewing your business’s economic forecast and what’s happening in the marketplace can help inform your decision, according to Amaral. “Read economist reports and look to what the experts are saying to help support your own decision and comfort levels.”
6 steps to plan your commercial real estate purchase
1. Assess your needs
A commercial real estate purchase is a complex and costly undertaking, so you’ll want to make sure your new property will meet your company’s needs for years to come. You can try our free commercial real estate assessment to determine whether a purchase is right for you at this time.
If you do decide to make a purchase, make sure to take the following into consideration:
- amount of space you need
- power, water, and heating and air conditioning
- machinery and equipment
- what you can afford
2. Assemble a team of advisors
Putting together the right team of advisors before you start shopping for a new business space can make all the difference.
Most commercial real estate deals require the following types of advisors to be completed.
- commercial real estate agent
- operational efficiency expert
- environmental consultant
- building inspector
3. Line up your financing
Getting approved for commercial real estate financing isn’t easy. Bankers will want to see high-quality financial statements and evidence that the profits you generate are being retained by your company. All of this will play a big role in determining whether you get the commercial real estate loan you want.
It's also a good idea to shop around for the best financing package. Don’t forget that while the interest rate is important, it’s far from the whole story. Other factors such as what percentage of the purchase a financial institution is willing to finance are equally, if not more, important.
You should also resist the temptation to sway lenders with overly optimistic forecasts—payment problems down the line can boost costs and reduce your room to manoeuvre.
4. Find the right location
Working with your advisors, determine what location is right for you. Retailers and professionals need a property that can easily be found by existing and new customers. Manufacturers, on the other hand, should think about easy access to highways and other modes of transportation.
Also think about how far your employees will need to travel to reach the new location. A building in a central, easily accessible location can give you a strategic advantage.
5. Plan for all costs
One of the biggest budgeting mistakes many businesses make when evaluating their commercial real estate purchase is underestimating—or worse, entirely missing—major expenses associated with the transaction. To avoid this potentially costly budgeting pitfall, make sure you’re taking all costs into account, including:
- purchase costs
- renovations and repairs
- closing costs
- moving costs
- operating costs
6. Do your due diligence
When you’ve finally found the right building for your business, it’s imperative to perform due diligence before making the purchase. This will help minimize risks and ensure the building is a sound investment.
- Go over all the documentation from the seller, including any current leases, maintenance contracts and title documents.
- Carefully examine the condition of the building, any liens and obligations as well as the insurance policy.
- Build a list of questions and issues to be checked, and assign them to your team.
What is the difference between commercial and residential real estate?
Residential real estate refers to private dwellings where people live. Although an entrepreneur may operate a small business out of their house, there are restrictions on the type of commercial activity that can be conducted within residential zoning regulations.
Unless a commercial real estate property is defined as mixed use—for example, tenants living above storefronts—it is intended to be for business operations only, not for residential use.
Learn how to buy a property for your business, including how to locate the right property and get financing, and negotiate the best purchase price in the free BDC guide Buying Commercial Real Estate.