Reality #1: If your business is profitable, you’ll probably qualify for a loan.
In the past, owner-users had opportunities to purchase properties with no money down. However, in today’s lending environment you really need to have some liquid cash and a good steady stream of income in order to qualify for a loan. Like the old adage goes, you can usually only get money when you don’t actually need the money. That’s not to say that you won’t be able to get a loan if every aspect of your financial house isn’t in order, but it will be a lot easier if your sales are up, your credit is good, and your bank account has a down payment in it.
If you have a cyclical business, or if you just lost a major account, then you may have to wait a few years before you can make your move in the market. While losing one account may not put you out of business, the bank you’re working with to get a loan will immediately notice and say, “Geez, your company’s sales went from $2.2 million to $1.1 million over the course of a few months. What happened?” I’ve seen this happen several times, and in most cases, the borrower doesn’t qualify for the loan.
So strike while the iron is hot. And if you can’t do that, then go back, retool, get out of the market for a little while, replace that big account, and try again in two or three years.
Reality #2: Buying commercial real estate can help you ride out business lows and maximize the highs.
As I’ve mentioned, real estate is always appreciating or depreciating; it rarely stagnates. This is generally a positive point for anyone who wants to invest in a building to house their own company, namely because the investment can help you ride out sales cycles, customer losses, or market shifts. Why? Because your overhead is staying the same, particularly if the local market is popping and rents are going through the roof. As an owner, you can escape those rent increases, and there’s not a landlord to toss you out. As long as you keep your building in good working order and manage the upkeep and maintenance on a regular basis, you can weather the business storms a little easier.
If the business climate is excellent and your company is doing well, you can up your personal income by paying yourself higher rents. If you have unused space in your building, you can lease that portion to a tenant for a fair market rate. This creates an ideal situation—that is, cash flow—for business owners who can more effectively ride out the lows and leverage the highs—all while their real estate is either appreciating or depreciating.
Reality #3: You may have to personally guarantee your commercial real estate loan.
Unless you can come up with a down payment of 35% (or more) of your target property’s sales price, you’ll probably have to personally guarantee the loan for your building. While that sounds like a big chunk of change, thinking back to chapter 2 (where I talked about controlling your fear), the important thing to consider is how much is at risk (your home, car, family’s quality of life, etc.) and whether the investment is worth the risk. If, for example, sales have dropped for your company over the past few years and there’s no improvement in sight, then you may want to sit tight and continue to lease for now (or find a new revenue stream to augment your decline in sales). Take a look at your business plan, your company’s track record, and the potential upsides to owning commercial real estate before jumping in.
Reality #4: Your company—and not you personally—has to be able to pay the monthly loan payments.
When you apply for a commercial real estate loan, banks are going to look carefully at your company’s ability to pay rent. You’ll pull out your QuickBooks spreadsheet, run your finger down the column on the left, and see that on an annual basis you shell out $174,000 in rent. Now, if your company’s net annual income is $500,000, you’ll probably be told something like, “OK, Mr./Mrs. Building Borrower, your annual occupancy payments and building operating expenses will increase from $170,000 to $230,000 [well under the $500,000 you’re netting annually], so you’re
going to qualify for your loan.” Now let’s say you personally are a millionaire with $2 million in your checking account but your business is barely breaking even. In other words, your business is not making any profit, but as an individual you have lots of cash. You go in and apply for a $900,000 loan. The bank is going to say, “Well, sorry, Mr./Mrs. Borrower, you don’t qualify for this loan.” You’re going to look at the bank and say, “What are you talking about? I could pay all cash for this building.” Here’s the bottom line: even if you personally could pay cash for your building, your company has to qualify to pay the monthly payments, not you as an individual. This is a very important point that a lot of people getting into the commercial side of the business tend to overlook, so keep it in mind as you formulate your own investment strategy.
Reality #5: You have to get yourself organized before you approach a lender for money.
If you give your lender everything it asked for (P&L statements for your business, three years of tax returns, etc.), you should be able to get a preapproval letter within 48 hours.
preapproval will allow you and your broker to focus on the size of property that you can afford to buy. It doesn’t make good business sense for you or your broker to begin looking until you have been prequalified for a specific loan amount.
Here’s what you’ll need to hand over to your bank in order to get approved:
THESE ARE THE ITEMS A BANK WILL NEED
TO PREAPPRO VE YOUR LOAN :
• 3 years of business tax returns
• 3 years of personal tax returns
• Personal financial statement
• Business debt schedule
• YTD interim financials—P&L and balance sheet
• Current paystubs for all owners and their spouses
Reality #6: Commercial real estate loans differ from residential mortgages in many ways.
When someone takes out a loan to pay for his or her primary home, the assumption is that the property will get paid for based on the fact that it provides a roof over that person’s head. (Of course, we saw this assumption dispelled during the most recent real estate downturn, when millions of people let their mortgages go into foreclosure or short sale, but that’s another book. . . .) Residential loans also span up to 30 years, whereas commercial loans are typically shorter in length. For the most part, the loan you take out to buy your first building will probably span 10–25 years, and both the interest rate and the points will be higher than what you’d normally pay for a residential loan. This is because commercial loans are seen as being more “risky” than their residential brethren. There’s also no private mortgage insurance (PMI) to cover the lender in case of default, and that reality is factored into the cost of the loan. Typically, commercial loans have no impounds (i.e., taking out taxes and insurance on a monthly basis). They are more sophisticated loan products because the people using them are more advanced and knowledgeable about the market, the terms, and the risks. When you get to this level, you’ll be expected to come to the table with a bit of knowledge about what you’re
getting into and how you’re going to responsibly pay off your loan over time.
Reality #7: The tax advantages of commercial real estate work in your favor.
I cover the main tax advantages associated with commercial real estate throughout this book, but I also want to point out the impact that these tax advantages have on the financing process.
For example, one of the biggest real estate tax benefits available comes in the form of deductions, or “tax write-offs,” that include costs associated with:
• Mortgage interest
• Property taxes
• Operating expenses
• Property depreciation
• Repairs and maintenance
Remember when I mentioned the value of having the best 10-year-old building on the block (in chapter 2)? Well, getting to that point requires ongoing maintenance, equipment repairs, and other investments that can either be amortized over several years as a major capital expense (e.g., a new roof ) or be used as a one-time tax write-off (e.g., a new air conditioner compressor that cost $800). Basically, Uncle Sam subsidizes you to maintain a top-of-the-line property. As a commercial property owner, you can also leverage depreciation on your Schedule E tax form. So if you own a building that produces a $2,000-per-month income (after all bills are paid on it), that equates to $24,000 annually. But because you can depreciate that building over a 39.5- year period—and let’s say the annual depreciation amount is $20,000—then you’re going to pay tax only on the difference (in this case, $4,000). That’s a pretty powerful savings that can directly impact your bottom line and help you accumulate wealth and save for your future.
