Apartments and commercial property

Buy property that’s valued by the income it brings in: apartment buildings, retail, office or industrial, on your own or with partners.

How it makes money

• Net operating income: rent from many tenants after operating costs.
• Value follows the income (value = NOI ÷ cap rate), so raising rents or cutting costs raises the value: $10,000 more NOI at a 7% cap rate is about $143,000 of value.
• Loan paydown and long-term appreciation, often shared with partners.

The honest risk

• Cash you need to start: A larger down payment than on a home loan, plus reserves and the cost of inspections and reports.
• Worst realistic outcome: The income doesn’t cover the loan payment. Commercial loans can come with balloon payments and personal guarantees.
• What you keep owing: Every loan payment, tax bill and repair, even when units are empty. A personal guarantee can make you owe more than the property is worth, and a balloon payment can force a sale or refinance at a bad time.
• How long a first deal takes: Months: commercial due diligence and loans take longer than for a house.

What goes wrong on a first deal

• Verify the rent roll, the last 12 months of income and costs, and tenant estoppels; sellers’ “pro forma” numbers are guesses.
• Commercial loans size on the income, often end in a balloon, and can carry personal-guarantee carve-outs.
• A Phase I environmental review before you’re committed, for most commercial property.

Your first steps

• Read the lessons on residential vs. commercial and traditional financing.
• Learn to read rent rolls and operating statements: NOI, cap rate and debt coverage.
• Talk with commercial lenders about down payment, DSCR, balloon terms and recourse.
• Build a team: commercial broker, real estate attorney, CPA and property manager.
• If you’ll raise money from others, learn the securities rules first.
• Run the numbers in the commercial income calculator.