Greetings from the metropolis of Cedar Crest, NM.! I just got back from taking my youth group to The Red Letter Rock Fest in Snyder, TX. A whole lot of driving, a whole lot of rockin’ and a whole lot of wind. Nothing stops the wind in West Texas. Never the less…..the kids had a blast and I lost my hearing. Wow….I am still recovering from the trip. Two hour naps in the middle of the day are part of my rehab….and possibly a part of my every day routine from now on.

Anyway…..

Like most real estate investors, I began with “no money down” residential deals. After a year or so of investing in houses, a few commercial investment opportunities came up and I made the jump. Although I still have several residential investment properties, commercial real estate is my preference.

There are several reasons why I like to invest in commercial real estate but the risk level is not one of them. There is a lot of risk involved in commercial real estate investing that goes beyond the asset and how the markets are doing. The “real” risk in commercial real estate investing is the fact that a large commercial deal will entail a lot of money and a lot of people. Money and people can be a lethal mix in any business transaction…especially large commercial transactions.

Before you run to the hills, understand that risk is just part of doing business and not a good reason not to invest in commercial real estate. The pros definitely out weight the cons (my opinion of course).

The bad news is there is no way to get around the risks when it comes to mixing money and people but the good news is there are actions you can take to minimize them.

So….what can you do to minimize the risks (mixing money and people)?
Plenty….

1. R.E.S.P.E.C.T.

   Before you do anything….have a healthy respect for your deal. Respect for your investment with regards to risk will drive you to take the precautions necessary to protect yourself and your investors (if you are recruiting investors).

2. Pay for good Advisors

   Your advisors are an important part of your team. DO NOT BE CHEAP! Good advisors (real estate attorney, asset protection attorney, CPA, mortgage broker, real estate agent/broker, insurance broker, property manager, mentor, etc.) are worth their weight in gold. Be willing to pay for it. Don’t cut commissions, don’t use prepaid legal, and don’t take short cuts when it comes to your advisors. Don’t ask your uncle Vincent because he had a year of law school.

3. Accept the advice from your advisors

   Okay….I know what you are thinking….but many people will listen and ignore their advisor’s advice. If you are going to pay your attorney $400 an hour….make sure you use the advice you are given. If you do not agree, get a second opinion but never ignore professional advice. Sure…question the advice and seek alternatives but ignoring advice will hurt you.

4. Partnerships

   I can go on and on about partnerships. I have had horrible partnerships as well as great ones. The problem is that horrible partnerships linger like garlic. Partnerships are like parenthood. It is easy to be a parent but difficult to be a good one. Time and time again, I have counseled many of my students on partnerships. The key thing I have learned is to prepare for the worst by having an operating agreement in place (done by an attorney). If things fall apart, your operating agreement will help soften the breakup. If your operating agreement is not done well, it could get ugly.

Obviously the list is much longer but I think you get the point. Being prepared for the worst will allow you to expect the best from your investment. Once you protect yourself on the “mixing people and money” side of the transaction, you can focus on the risks associated with the property. Market conditions, due diligence, real estate cycles, and all the other fun stuff.

Until next time……rob

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This Post is from the BiggerPockets Real Estate Blog. Copyright © 2008 BiggerPockets, Inc. All Rights Reserved.

Is Commercial Real Estate Investing Risky? Yes It Is! But It’s Not What You Think

Many aspiring apartment building investors are eager to buy their first apartment building but many times they don’t have the requisite 20% financing that banks and commercial lenders require. There are certainly creative ways to overcome this obstacle, however, it should be stressed that there is no one answer or magic solution that will apply to every deal.

The apartment building buyer should first and foremost evaluate the property to make sure that the property will “debt service”. This simply means that the total income produced from the property will be able to pay for all of the annual expenses including the principle, interest, taxes and insurance. In addition to covering all of these expenses the property should also show a profit as well. Banks require a debt service coverage ratio of 1.2 or 1.25 on most apartment building investment deals. After determining that the apartment building will have a positive cash flow and a debt service coverage ratio of at least 1.2 the investor can than look for creative ways to raise cash for the down payment.

For example’s sake we will assume that the investor is looking at a 15 unit apartment building that has a purchase price of $1,000,000.00. We will also assume that the property will have a debt service coverage of 1.25 with a 30 year, fixed rate, commercial mortgage that has a fixed rate of 6.5%. We will also assume that the apartment building buyer has about $75,000.00 in cash to apply towards the down payment. The buyer now needs to raise about $125,000.00 to reach $200,000.00.

In my opinion, the best method to raise these funds is to seek out other investors and form a limited partnership. If the apartment building investor has no experience with limited partnerships then he or she should consult a qualified real estate attorney who can facilitate the partnership and prepare the legal paperwork. In brief, the investor will act as a general partner and the other investors will act as limited partners. The limited partners have a limited liability and they are responsible only responsible for debts incurred to the extent of their registered investment and they have management authority. Therefore he general partner will make the decisions about the property and undertake the management and the limited partners will share in the profits of the investment according to the extent of their original investment and as outlined in the partnership agreement. The limited partnership is a flexible and useful method for the individual investor to raise capital and invest in larger sized projects then he or she would normally be able to without actually borrowing more money.

The difficulty the new investor will face with raising money in a limited partnership will be convincing limited partners to come on board and invest their hard earned money in your project. For this reason it is necessary to have clear and accurate financial projections. It will also be more difficult to find partners if the investor has little or no experience with commercial real estate investments. For this reason, the investor may want to consider approaching family, friends, or other business associates to find qualified partners. Another avenue to explore would be to network at investment clubs.

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This Post is from the BiggerPockets Real Estate Blog. Copyright © 2008 BiggerPockets, Inc. All Rights Reserved.

Finance Apartment Building Purchase with a Limited Partnership?