A beneficial way to build your investment portfolio is through commercial real estate. Before investing in your next capital venture, we recommend understanding what goes into an investment property so you are fully equipped for success.
Whether you’re starting a new business venture or acquired properties already, it’s important to remember these five tips to ensure you start your next venture on the right foot.
Down Payment Costs
The down payment required for a commercial real estate loan is higher than an owner occupied home loan. It also has more regulations tied to it. For a commercial real estate loan, down payments typically begin at 20% of the purchase price whereas a home you purchase to live in can begin with a 3% down payment.
When thinking about the property you are purchasing, consider the amount of capital you need upfront before finalizing the purchase. Ensure you have the right amount of funding to pay the down payment costs associated with the deal.
Commercial real estate loans are associated with higher down payment costs because they do not have mortgage insurance. However, the benefit of placing a higher down payment on a property allows you to reduce the overall cost and interest rate accrued over time.
For example, a down payment for a property with a value of $1,000,000 would require a $200,000 down payment. You would then owe $800,000 for the property, and only be charged interest for the amount after the down payment. There isn’t an interest charge on the $200,000 paid upfront through the down payment, saving you money in the long run.
Property Location
Location, location, location. One of the most important pillars of seeking an investment property is location. When finding properties you may want to invest in, consider where they reside. You want to invest in a property that will thrive and be successful.
Research market trends, market value, areas with high growth and development. Neighborhoods play a key role in the value of your property. Depending on the type of property you’re investing in, consider these factors when making your decision:
- Surrounding community
- Nearby attractions such as malls, restaurants, theaters
- School districts
- Low property taxes
- Public transportation
- Crime rates
- Type of job market surrounding the area
Opportunity zones are another factor to consider when searching for commercial properties to invest in. According to the Internal Revenue Service (IRS), an opportunity zone, “is an economically distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.”
They are designed to promote and encourage economic development in specific areas in low-income and undercapitalized communities nominated by the state, District of Columbia or U.S territory that is certified by the Secretary of the U.S treasury.
Tax Policy Center explains the three benefits of investing in opportunity zones:
- “Temporary deferral of taxes on previously earned capital gains
- Basis step-up of previously earned capital gains invested
- Permanent exclusion of taxable income on new gains.”
Determine the Right Loan Type for You
Applying for a commercial real estate loan is not a one size fits all process. Each loan relies on a myriad of factors such as:
- Credit score
- Tax returns
- Financial history
- Personal information
Depending on your business plan and property you decide to invest in, there are different lending options available to you. A common misconception is that the only way to obtain a loan is through a commercial bank.
It may be beneficial to shop the market to research a business loan rate that works best for you. When choosing a loan type, consider the interest rate associated with it. Typically, investment properties are associated with higher interest rates than traditional mortgage rates.
A few alternative options available are to secure financing through private or alternative lending sources. Our team at Innovative Capital has developed relationships with both commercial and private lenders and is well versed in helping our clients find the best loan to meet their needs. We aim to support our clients as they determine how to apply for the right one.
Keep the 1% Rule in Mind
What is the 1% rule?
The 1% rule helps you calculate the appropriate amount of rent to charge for an investment property. It ensures that you as an investor at least break even, and ideally profit from rental payments to cover mortgage costs.
The value helps you as an investor charge correct rent fees that cover expenses of mortgages and other fees associated with owning the property. Finding the right value requires taking the purchase price of the property, adding any additional repair costs, and multiplying it by 1%.
With the 1% rule, an investment property purchased for $500,000 would require a monthly rental payment of $5,000 or less.
Keep the 1% rule in mind when considering the purchase price of your investment property. We recommend researching rental prices of properties in the surrounding areas to see if they land in the same range that would keep you near or under the 1% range to make a profit and stay competitive.
Know Added Costs Involved
Depending on the property you invest in, there are different potential costs involved.
- Landlord insurance- typically covers general dmange, lost rental income and liability protection
- Maintenance costs- pipes burst, floors need repairing and roofs need replacing. These charges can add up unexpectedly if a problem with the building arises.
What is the 5% rule?
The 5% rule applies to spending costs on a property. It includes damages, repairs and normal maintenance upkeep. As an investor, keep in mind that about 5% of your income can funnel into maintenance costs. It doesn’t mean each month will require 5% in maintenance, it can fluctuate.
In the example above, you can expect that 5% of the $5,000 monthly rental charge, $250, will go towards maintaining the property. This means that monthly, you technically profit $4,750.
Looking to fund a real estate investment property? Partner with our team here at Innovative Capital Corporation. Our team of experts has the experience and the resources to match you with the right lender. For more information, reach out to our team today.