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As
you’ve read here a number of times - purchasing commercial real estate is a
great way to build generational wealth. It’s like a jelly of the month club. By
that, I mean the gift that keeps on giving! Many who read this column founded
an enterprise housed in a parcel of commercial real estate which they also own.
So. The occupying company earns income through its business operation and pays
rent for use of the building. Company value increases over time and the address
appreciates. A double whammy! Southern California has countless entrepreneurial
stories whereby a generation took a risk, formed a company, bought a location
and succeeding family members benefited. I have the privilege of counseling
these family owned and operated manufacturing and logistics businesses.
Recently,
a conversation occurred which I believed column worthy. Specifically, how much
should be allocated for a down payment when considering a buy? The easy answer
is 10% of the purchase price if leveraged through the Small Business
Administration and 20-30% when financed conventionally. Boom. Done. See y’all
next week. But, there is substantially more to the story of originating a loan.
So please stay tuned for a minute more.
In
addition to the 10-30%, suggested would be to budget for the following:
Appraisal. Regardless of your lender choice -
SBA, bank, insurance company, or hard money - an appraisal will be completed.
Contained within the bank’s underwriting - this confirms the price paid is in
line with the market. Plan on $2500-$5000 for this review.
Environmental. Lurking beneath the surface of your
purchase could be a problem. These unseen issues are caused by something toxic
deposited in the soil. A review of the previous occupants in the building,
messy neighbors, and the smokestack down the street combined with a look at old
aerial photos - forms what is known as a phase I environmental report.
Generally, this does the trick and provides a clean bill of health. If
recognized environment concerns - such as stained concrete or containers of
waste - abound, a phase II will be employed. Soil borings are sampled and
tested. Recommendations range from no further action to remediation. Have you
ever witnessed a pile of dirt inside yellow tape next to a gas pump at your
local station? No. It’s not an episode of CSI. Aeration is one way to get the
bad stuff out of the soil. Plan on $2500 for a Phase I to ?? If remediation is
required.
Legal. You’re going to want an attorney to review the purchase
agreement, title commitment, and draw your LLC formation documents. Budget
around $10,000.
Escrow and title. Sure. Seller pays for a standard
policy but any lender policies or extended coverage are yours to bear. Plus,
you’ll pay 1/2 of the escrow fees. Another $10,000 but dependent upon deal
size.
Survey. Not always necessary unless you’re after an extended policy
of title insurance. Unrecorded easements, abandoned driveways, and recorded
leases are typically not covered with a standard policy. Utility locations,
property lines, and underground pipes are clearly mapped as well. $5000 is
reasonable.
Loan points. In addition to the interest
payments due over the term of your debt - you’ll pay a percentage of your loan
amount to the bank. 1-2% is pretty typical.
Cost segregation. One of the really cool things
about owning commercial real estate is the depreciation which lowers your
income tax burden. The improved portion of your parcel - the buildings - can be
depreciated over 39 years on a straight line. 1/39th each year. But, other
components of the improvements such as walls, doors, glass, and air
conditioning have a shorter useful life and if properly segregated - can be
written off sooner. Usually your CPA can help with this. She’ll want to be
paid, though. $15,000 seems fair.
Once
you become the owner, gather and total your receipts. Add all you spent to the
10-30% down payment. What results is the “true” investment into your buy.