Anatomy of a Commercial Real Estate Transaction for California Real Estate Investors

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Author: Staff

When it comes to choosing an investment property in California, real estate investors have a vast array of options. They can purchase a single-family dwelling and rent it to a tenant, or renovate it and flip it. They can purchase a multi-family dwelling or an apartment building for rental purposes. Commercial real estate offers even more possibilities, such as buying an existing office or retail building, renovating a commercial building, or purchasing raw land to develop from the ground up. Commercial investments often carry greater possibilities for revenue and profit, but they also often involve more risk, and more up-front work. The following is a general overview of the steps in a commercial real estate transaction. This hypothetical transaction involves the purchase of a property with the intention of renovating or developing it for commercial use.

Step 1: Find a Property and Build Your Team

Before you look at a single property, you should identify your goals and make a plan. Do you want to purchase a property that you can sell at a short-term profit, or do you intend to derive income from the property through rent payments? How much risk can you take on? How much time, effort, and capital are you willing and/or able to invest? Do you have investment partners? Are you putting together a real-estate syndicate? Do you need investment partners to contribute money or expertise? And so forth.

Next, you should visit many properties. Whether a property is “right” for you depends on your investment goals and your budget for both purchasing and maintaining a commercial property, among many other factors. Consider the current uses of these properties, and whether they fit your intended use or could be adapted to that use. Determine whether there are any uses that are prohibited for a property because of zoning or deed restrictions. Find out what permits you will need from multiple levels of government. Investigate each property’s potential for rent income, and the economic conditions of the surrounding areas. Above all else, find out why the owner is selling.

You can start building your team now that you know what kind of project you want to pursue. You will need expert assistance, most likely starting with a lawyer, an accountant, a real estate agent, and a mortgage broker. You might also need to consult with engineers, architects, tax specialists, environment experts, and others.

Step 2: Financing

Unless you are willing and able to pay the full purchase price in cash, you will need to secure financing. Residential real estate financing is commonly known as a mortgage loan. Commercial transactions may involve several types of loans, with different terms than residential loans.

First, you need a loan to cover the purchase price. Much like a mortgage, this type of loan is secured by the property, giving the lender the right to foreclose in the event of a default. Commercial loans generally require a lower loan-to-value (LTV) ratio than residential loans. This is the ratio of the amount of the loan to the lower of the total value of the property or the purchase price. Commercial loans usually have a maximum LTV of 80%, so be prepared to have 20% in cash.

Many commercial loans have prepayment penalties, which protects the lender’s expected interest revenue. Unlike mortgage loans that allow monthly payments for up to thirty years, commercial loans often involve a balloon payment after a much shorter repayment period.

If you intend to make renovations or build on the property, you should also obtain a construction loan. This is a short-term loan that covers construction costs. It is considered higher-risk, so it often involves higher interest rates. In the event the construction or renovation encounters difficulties, a bridge loan might be necessary to cover additional expenses.

Once construction or renovation is complete, the construction loan and any bridge loans must be repaid. Depending on how long this phase of the project takes, the balloon payment for the original loan might also be approaching. At this point, a permanent loan allows you to pay off the other loans. Since the property should now be ready to generate income, this loan is considered low-risk, and therefore has a lower interest rate and better terms for repayment.

You should determine what loans will be necessary, and obtain the assistance of one or more lenders, before the next step.

Step 3: Make an Offer

Once you have identified a property, you can make an offer to the seller by sending them a letter of intent, which provides an outline of the terms of the sale. The seller may make a counter-offer. Once someone accepts the other’s offer or counter-offer, both parties should sign a sales contract.

Step 4: Due Diligence

Now that there is real money on the table, it is time to research the property again. Be even more thorough this time. The due diligence period allows you, as the buyer, to make sure that everything the seller told you about the property is true, and that there are no defects in title or on the property itself. It also allows you to resolve any concerns from your lender and the title company.

Step 5: Escrow and Closing

Prior to or at closing, an escrow agent receives all of the funds required for the sale. Just like in residential real estate transactions, the escrow agent is a neutral party who can protect both parties’ interests. At closing, the seller signs a deed and other documents. You sign a promissory note and other documents. The escrow agent disburses money to the seller, and the property is yours.

Step 6: Construction or Renovations

Now that you own the property, it is time to get moving. You can close on the construction loan at this point, and you can officially hire the contractors and other people you talked to back during Step 1.

How the rest of this step proceeds depends entirely on the type of property you chose and the type of construction or renovations you are doing. Hopefully everything will proceed smoothly according to plan, but you should be able to call for a bridge loan if they do not.

Step 7: Permanent Loan Closing

Once construction is complete, you can close on your permanent loan, pay the other lenders, and get down to business.

Step 8: Get Down to Business

We need to know more about what you are doing before we can tell you much about this step. Regardless, take a moment and be proud of everything you have done so far!

More Blog Posts:

What California Real Estate Investors Should Know About Construction Contractors, Titles and Deeds, January 8, 2019

What California Real Estate Investors Should Consider When Purchasing Real Property at Foreclosure Auctions, Titles and Deeds, December 15, 2018

Due Diligence Tips for Commercial Property Purchases in California, Titles and Deeds, October 9, 2018