Hello,

I am looking at a building that has 3 office spaces and 2 apartments, currently both apartments and 1 office is rented/leased. I have never owned a commercial property before and would like to get as much information about being a commercial property owner...i.e. things to look at like costs associated, insurances...etc. As far as I know currently each renter pays for all of their utilities, so the only thing that I know of having to pay for myself is the loan, taxes, and repairs.

I have a strong financial standing/credit and enough money to be able to put enough down and think I have enough to cover me for sometime if some of the units are not rented or the renters move out...etc, but how much reserve do I need for this type of situation?

Is it better to setup some type of corporation (LLC or Incorporated...etc) to purchase this property? If so which is better and why?

Also if someone has any ideas/thoughts that I should look at in consideration for purchasing and being a commercial property owner I would greatly appreciate it.

Thanks in advance.

Hi,

While I don't have actual commercial rental property experience I too have been looking for commercial properties like the one you have described ...

and based on my searches one thing i found to be definte thing to do based on many friends' and attorney experiences is putting the commercial property in some proper legal structure like LLC and your personal assets in family limited partnerships and making some arrangements between the two such that if a tenant's customer falls on the property you don't get sued for your own personal assets like home in addition to the commercial property as far as i have been told so far that owner is open to all kinds of litigations, though may not be true everywhere so legal structure advice from proper attorney would be highly recommended.

good luck

biszer1

Investing on income producing properties is all about the “net operating income or NOI” that the property produces. Taxes, insurance, utilities, management, and maintenance are the usual components that are deducted from the rental income in order to get to the NOI.

The following are some thoughts about it:

1- Normally, you do not make the calculations based on 100% occupancy {even if you currently have 100% occupancy}. The best is to use market vacancy rates, the second best is using a 5% vacancy.

2- You might want to take a look at the spreadsheet that I have at http://www.loanuniverse.com/sensitivity.html to kind of guide you as to how the NOI and the debt service is calculated.

3- I would not place any reserves aside, but just make sure that a portion of your assets is liquid enough so that you can pay the mortgage if a couple of tenants move out at once.

4- I have seen investors hold commercial properties in both types of entities {LLCs and Corporations}. I do not see any advantages in using either as you can elect to be a subchapter S corporation and get the same pass-through tax advantage. I think there are some benefits to the way earnings can be distributed among the members in an LLC, but this is going to be a one-member entity so I don’t see any. Nevertheless, I am not an attorney or accountant so consult one.

5- Do not buy income property on potential as you will be speculating other than investing. Someone mentioned here that they were thinking of buying a property but could not get a loan for it because it was appraising way lower than purchase price. This individual also mentioned that he intended to hold the property for at least ten years hoping for an increase in value. In other words, the buyer was willing to put up with returns that are lower than market for ten years for something that may or may not happen.

6- Strong financial standing, good credit, and enough money give you the opportunity to shop around. Commercial lenders normally do not ask for any money to begin their due diligence and only ask for money in exchange for a written commitment. This means that you can shop around with several until you get a good deal.

Good luck.

Thanks a lot, this is useful information and I greatly appreciate it.

I went and looked at the property today and have an appointment with a realtor tomorrow to go through it. I would imagine that they could provide me with a rental history, but how far back do I need to look at something like this? Also for the future what are the recommended leasing terms (1, 2, 3 yr...etc).

Also about the reserves, should I not have anything aside for repairs either? I figured when (and if) I am making a profit that I could setup an account and dump a certain amount aside for misc. expenses for this property, so that I don't get into a jam...

Again thanks for the information.

Yes, you should set aside amounts for both maint as well as capital replacement reserves. Maint is for the smaller items, think "repair." While capital replacements are bigger things, hence the term "replace." Leaky faucet is a repair, a new roof is a replacement. Accountingwise they are treated quite differently, the former is deductible against income, the latter has to be added to the basis of the property (which starts with the amount you paid, then is depreciated over time).

As to entity, i HIGHLY recommend an LLC over a corporation. For most situations, the LLC provides all of the benefits you are looking for. A very basic way of looking at it is, with the LLC, you treat the tax/accounting issues as if you owned it personally (pass-thru) yet you get the corporation-type protection from liability claims against you. Thats where the LLC differs from the Corp. The rules for how you operate a corp are kind of stringent, and if you screw it up, then creditors can "pierce the corporate veil" to get at your assets. It is very hard to pierce an LLC, because there are virtually no formalities to observe. LLCs get tricky if you have mulitple partners or weird financial structures. But if its just you (and maybe a partner) then all you pretty much do is fill out a one page form for the state and you have at least some level of protection. If you go through the many steps of incorporating, then dont observe the corporate rules, its just as if it doesnt exist at all. Anyhoo, some might disagree, but thats my observation, both as a lawyer and a real estate investor. Put each property in their own LLC. (sometimes to keep it straight, name each LLC with the address of the property)

One last thing, I understand that in virtually all cases in which you will find yourself, even if the property is in the LLC (or corp), when you apply for a loan, you will have to guarantee the loan yourself personally, so dont think of *that* kind of liability as the kind you can get around. You just want to protect yourself from the weirdo tenant that is looking for a big pay day as they "slip" on the sidewalk

best of luck!

An LLC should be fine and depending on what state the property is in you may just have to close in a corporate name. You should ofcourse make financial sense of the investment i.e Based on the NOI (Net operating income) you can figure out what mortgage you can afford (With good credit ofocurse). You should also be taking a look at the condition of the building; what if any repairs/rennovations may be need, in addition to the local market/economic conditions of the area where the property is including the current taxes and their propensity to increase. If you have any operating statements for the property, i would be more than happy to take a look. Leme know if you have any questions. Thanks!

Also please note that in some states the LLC is not considered "valid" unless you have more than one member, such is California. I ran into that problem, California WILL let you have an LLC with just one member, BUT you do not have protection unless you have more than one member. So please check your state laws on LLC's. Things you learn when filing business paperwork yourself