In the late 1970s and early 1980s lease option sales represented one of the most used financing instruments. This was a very popular way of buying real estate in a time when 100% financing wasn’t available and hard moneylenders were even more difficult to find. Just a few people are aware of the fact that lease options are considered by banks as a violation of the due on sale clause. Basically, if the loan wasn’t paid off in full and if the lender finds out that the owner has accepted a lease option agreement, he could call the deed of trust or mortgage loan due and foreclose it.
When options are properly understood and prepared, as well as used correctly, can represent a terrific way of conserving your capital, reducing risks, creating leverage and gaining control of the commercial real estate properties while optimizing your immediate resale profit potential.
What is a commercial real estate option?
In legal terms, it is an agreement between the optionee- the party who owns the option- and the party selling the option- the optionor. Its purpose is to grant to the optionee the irrevocable, unrestricted and exclusive right of buying the property from the optionor during a predetermined period of time. There are six key elements that define real estate options and these are detailed below:
- The Optionee: the party that buys a real estate option.
- The Optionor: the party that sells a real estate option.
- The real estate option: the irrevocable, unrestricted and exclusive right to purchase a property for a fixed price for a predetermined period of time.
- The option consideration: the fixed price paid by the optionee for purchasing the real estate option from the optionor.
- The option period: the period of time predetermined and mentioned in the real estate option agreement that refers to a particular option.
- The Exercise of option: When the optionee notifies the optionor, in writing, that by purchasing the property under option he will exercise the real estate option.
What are the advantages of a commercial real estate option strategy?
Compared with flipping hard real estate, an option strategy has more advantages from a speculative point of view. Some investors claim that the most profitable strategy is flipping real estate, but there are some roadblocks that shouldn’t go unmentioned:
Scrutiny from lenders and title and escrow agents for possible fraud
As long as you use them correctly, real estate options represent a profitable low risk technique and an excellent-profit potential property control tool.
What are the best types of commercial properties for an option strategy?
It is advised to purchase options for properties that are in demand or are going to be in demand through added demand from potential space users or creative repurposing. Below we will list some of the most important types of assets that can be targeted for an option strategy:
Badly managed rental commercial real estate properties that can be turned around
Commercial properties that can be up-zoned for more and be best used
Properties that have a functional obsolesce and can be used in other purposes
Filthy, dirty, run-down commercial properties that can be cleaned up
How do you find option properties?
For finding sellers of assets that are interested in option strategy you need to elaborate a multipronged attach. The most recommended techniques for doing this are: direct mail, classified ads and Internet marketing.
You need to develop a multipronged attack to find sellers of assets that would consider option strategy. The best techniques that I would recommend are as follows:
Direct mail is probably the best one available as it also targets out-of-town owners. You shouldn’t neglect this category as it is composed of absentee property owners that have inherited a commercial property or that have relocated and need to sell that specific property even if they no longer live in that town. For them, the property represents a real problem and they need an urgent solution for it. The most effective way of contacting them is through a letter or a postcard.
Reselling your option for a profit
After you have found, negotiated and signed an agreement for an option you should record an option memorandum. This needs to be done at the country records vault so that your option position is recognized by the authorities and noted in the title’s chain. The following move is to profit from this option.
The first and most important thing you need to do is to calculate its resale price. It is recommended to try to sell the commercial real estate property option for at least 5%-10% of its market price by having in mind the option buyers’ end.
For instance, if the commercial property’s fair market price is $100,000 for which you have an option to purchase of $60,000 then you should set your option’s price at $10,000. In the end, you would be correctly compensated for the effort and time you invested in getting that property under option and the buyer would also get a $30,000 discount from the fair price available on the market.
The next step needed for reselling the commercial real estate option is to compile an information package that offers the below details:
The type of architectural style and type of construction as well as the year when the property was built.
The commercial property’s geographical location as well as any particular benefits or features about that specific area.
A short description of the property’s interior such as the geometrical shape of the building, the square footage, the spacing between interior support columns, overhead door heights and ceiling, the size and shape of the lot, and the heating and cooling system.
A very valuable tip is to market the property, not the option. Remember that you are selling the commercial real estate asset that is targeted by the real estate option agreement.
Any investor that wants to profit from the commercial real estate market needs to know that real estate options represent a terrific tool that can’t miss from your portfolio of investment strategies. As long as you use this powerful strategy creatively you are sure to profit from your investment decisions.
Of course, investing in commercial real estate properties implies numerous other particularities that you must be aware of before you start walking on this road. There are so many financial advantages and risks that are associated with this practice that one needs extensive specific research and knowledge before completing the transition. Below we detailed the various and intricate particularities of buying a commercial real estate property.
Finding commercial real estate properties
If you ask any real estate expert about the advantages of investing in a commercial property you will have to face a very long debate on why commercial properties are more profitable than residential real estate. The thing is that commercial property owners adore the relatively open playing field, the extra cash flow, the abundant market for good, the beneficial economies of scale, the bigger payoff from commercial real estate and the affordable property managers.
The questions that preoccupy every investor are: What separates the great deals from the rags? And how do you evaluate the best commercial properties?
As in every aspect of our lives, a profitable decision is based on decent guidelines. Below we will present one that will allow you to recognize an excellent commercial real estate property deal.
Find out what the insiders know
The first thing is to learn how to think like an expert. To be a player, you must know that commercial real estate is valued distinctly than residential property. The usable square footage is the main factor for determining the income on a commercial real estate property. Also, commercial properties generate a higher cash flow. Furthermore, commercial property leases are for a longer period of time than the ones for family residences. And let’s not forget that commercial property lenders require you to have at least 30% of the property’s value.
Create a plan of action
When you are considering investing in commercial real estate it is essential to set some parameters. What profit do you expect to get from this deal? What is the amount you can pay for the property? Who are the key players? What is the rental space you need to fill? How many tenants are already paying rent?
How to identify a good deal
Real estate experts know how to recognize a good business opportunity when they see it. Their secret is to always have an exit strategy, to know how to assess risks, to identify damages that need repairs and to calculate if the property corresponds to their financial goals.
What are the commercial real estate property metrics?
Net Operating Income(NOI)
The Net Operating Income of a commercial real estate property represents the difference between the property’s first year gross operating income and the operating expenses for the same period of time. The value should be positive.
The “cap” or capitalization rate of a real estate property is useful for determining the value of income generated by commercial properties. For instance, in case of an apartment complex that includes five units or even more, smaller strip malls or commercial office buildings are properties for which we can calculate the cap rate. The role of cap rates is to offer a good estimation of the net present value of future cash flow or profits. This process is also known as capitalization of earnings.
Cash on Cash
Usually, those commercial real estate investors that are considering financing as an option for buying a commercial real estate property are the ones who use the cash on cash formula for making a comparison between the performances of competing properties during the first year. Cash and cash takes into consideration the fact that 100% cash isn’t necessary for buying the commercial real estate property as well as the fact that the investor will use a part of the NOI to pay the mortgage. In order to use cash on cash, investors need to first calculate the value of the investment necessary for buying the property, or their initial investment.
You need motivated sellers
The same rule applies to any business- customers define the magnitude of your success. This is why it is essential to find them and identify those who are eager and ready to sell the commercial property below the market’s value. In commercial real estate there is no deal until the investor finds a motivated seller. He is usually a person with an urgent reason to sell the property at a price that is below the market’s value. When the seller isn’t motivated, he won’t be eager to negotiate.
About Neighborhood “Farming”
You can evaluate a commercial real estate property by taking a look at its neighborhood. There are several ways of studying this aspect, like talking to other neighborhood owners, going to open houses and looking for vacancies.
How to search for commercial properties
When you are searching for great commercial real estate properties you should be adaptable and diversify your options. Read the classified ads, use the Internet and hire bird dogs to search and retrieve the best commercial properties offers. In exchange for a small referral fee, real estate bird dogs can identify valuable investment opportunities.
Identifying the right property
When you are looking to buy a suitable commercial real estate property there are numerous things you should consider. Location isn’t the only crucial factor; there are many others that make the difference between a profitable investment opportunity and a disastrous one.
This is still the most important criteria because any wise investor will look for properties that are near his workers, customers, suppliers or vendors. You want customers to come to you so access to highways, railways and shipping lanes are also important.
Now that you have decided on the best location, you need to think about how the property was used, if there are any potential liability issues, environmental concerns and of its wear and tear status.
If you have an advertising firm then you surely need a commercial office space. But if you have a manufacturing business then you will likely need an industrial space. And lastly, you have to first check if the location allows you to use the property for what you need.
Limitations on interior and exterior
It is possible that due to building codes or zoning laws or covenants, you will be limited on what changes or alterations you can bring to the commercial property. For instance, a building from the historic area is subject to many restrictions regarding modifications that can be made to its exterior design.
Access and parking
Don’t forget to find out how easy to access the communication routes are and if there are any parking facilities available.
Opportunity for expansion or leasing
Investors are always considering the growth of their business so for them it is essential to know if the commercial real estate property offers the chance of expanding or if the business won’t grow as expected then is it possible to lease the extra space?
The thing is that investing in commercial real estate properties involves a series of very complex actions, like getting a great price, farming neighborhoods, finding motivated sellers, building relationships with property owners and having the proper financing strategy.