In the world of Arizona commercial real estate, mistakes are unavoidable, particularly for novice buyers. Sooner of later, even the most experienced commercial real estate investor will commit a blunder. Because of the high stakes involved in commercial real estate investing, however, it’s in your best interest to do everything you can to avoid mistakes. For this reason, we’ve compiled a list of the most common commercial real estate mistakes that investors make. By becoming aware of these frequent mistakes, you can take steps to avoid making them yourself when investing in properties in the Phoenix metro area.
- Disregarding the conditions of the local market. When assessing Arizona commercial real estate investments, buyers must perform due diligence on both the property and the market. Between the two, the conditions of the local market are the more important factor. While a good property in a bad location can result in massive losses, a bad property in a good market could be a windfall for the investor. In order to determine which properties are which, investors should analyze several demographic trends, including income, population growth, and employment, for the local area. Your analysis will reveal where opportunities lie and what types of properties are most in demand. Investors can easily find this information online for major Arizona cities like Tucson, Phoenix, Flagstaff, and Scottsdale.
- Insufficient due diligence with the property. The second aspect of due diligence is the evaluation of the commercial property’s condition. When evaluating a property’s condition, you will need to consider things like environmental concerns, building systems, and structural components. Other important items include zoning, survey, title, and use of land regulations. Also don’t get overzealous in your desire to do everything yourself because you think it will save you money. Unless you have considerable experience, fixing up commercial real estate is not a do-it-yourself project. If you attempt to do something on your own and make a mistake, you will have to hire a professional to fix it, which could end up costing double what it would have to hire a professional from the start. Ask professionals who come highly recommended for estimates on how much it will cost to fix whatever you find wrong with your commercial property.
- Crunching the numbers incorrectly. Arizona real estate investing is basically a numbers game. Value hinges on your net operating income, or gross revenue less operating expenses. For this reason, you want concrete operating figures and not income projections or estimations of future expenses. When you value the property, do so based on your present income rather than projected income. Remember that every assumption you make when crunching the numbers raises your risk significantly. You shouldn’t assume that you can cut corners and reduce expenses or boost your income by ratcheting up the rents once you assume possession of the property. Adjusting assumptions can change the bottom line into whatever the projector wants to achieve, but reality is usually a far cry from these projections. Whenever possible, avoid assumptions and base your calculations on real operating numbers.
- Borrowing too much. Borrowing too much, also called over-leveraging, is a death knell in the Arizona commercial real estate business. Over-leveraged deals are not uncommon, but without a solid plan in place and adequate capital, they are usually catastrophic. A fatal mistake many commercial real estate investors make is using 100% financing. This over-borrowing eventually catches up to the investor, who ends up unable to make the payments on the commercial real estate loan. Using leverage appropriately requires a combination of investment strategy and proper deal structure. You should evaluate your investment property in terms of the break-even ratio. To compute the break-even ratio, add operating expenses to the debt service and divide that sum by gross potential income. If your break-even ratio is higher than 80%, your deal structure requires absolute perfection in order to succeed, which is a risky proposition.
- Failing to develop several exit strategies. A good investment plan should take into account all of the findings of the due diligence investigation and describe every potential outcome of the investment, from the best scenario to the worst. Make sure you ask yourself why you believe you can run the commercial property better than the former owner did. If you cannot answer that question specifically, you will probably not do better and may, in fact, do worse. Your investment plan should explain in detail how you will manage the property, what improvements you will make and how much they will cost, how long those improvements will take, how you will get out of the deal if things go awry, and how you will access your profits if thing go according to plan. The answers to these questions will produce a realistic and practical plan to maximize the property’s value in the least amount of time possible. Most experts recommend that Arizona commercial real estate investors have at least three possible exit strategies, but many investors have six or more. Remember the adage that if you don’t have a strategy to get your money out of the property, you will quickly be out of money.