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3 Things To Watch Out For When Investing In Real Estate

January 25, 2025

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First of all as a commercial real estate broker I want to recommend that you stay away from residential properties and go with commercial properties. Unless you need to make some quick cash by doing a fix and flip, the returns are nowhere near what you will experience in commercial real estate and there are federal regulations to comply with. Now that that’s out of the way, here we go.

3 Things To Watch Out For When Investing In Real Estate

1. Cash Flow

I know that seems obvious but it still needs to be said. Many new investors, especially if they are leaving the residential investing space to get into commercial, will be happy with low cash flow or even heaven forbid, a negative cash flow. Every negative cash flow property has its own set of circumstances. If a property is vacant and in need of redevelopment then you have a situation where negative cash flow can be tolerable for a period of time.

I love buying vacant properties because I can usually buy them for a really great price. In commercial real estate the value of a property is based on how much income it generates. If you are buying a negative cash flow property the purchase price should be negotiated to reflect that. Otherwise, steer clear!

2. Leases

One of the most important items to inspect is not the roof, the plumbing or the air conditioning. It’s the leases. Those items are important but the leases can kill your deal much quicker. If you are looking at a multi tenant property and half the leases are expiring in 6 months you have a ticking time bomb situation. If the tenants agree to renewing the leases either under their renewal option if they have one, or under your new terms then the problem could be averted. Otherwise this is at least a reason to start negotiating on the price.

Other lease items to look for: How does the current lease rate compare with the market rates for comparable properties? Is the lease a Triple Net Lease (NNN) where the tenant pays the property taxes, insurance, and maintenance costs in addition to the monthly rent - highly desired in most cases. Do the NNN charges need to be updated? Are they violating their lease terms in any way that you are concerned about? Many inexperienced commercial investors overlook important details in the leases. Be careful!

Solution: As part of your due diligence activities during the contract’s feasibility period, talk to every tenant. Ask them questions. Do you intend to renew? Will you commit to renewing early and under new terms if necessary? How can I work with you in order to have you stay on as a tenant? While you’re at it ask them if there are any problems you need to be aware of should you become their new landlord.

3. Two little words: Pro Forma.

As far as I am concerned Pro Forma is code for wishful thinking. When you’re looking at a property and the seller gives you numbers as a pro forma that means they are not real numbers.

Example: “This property has a pro forma Cap Rate of 10%.” That means they aren’t currently getting a 10% Cap Rate (a type of measure of annual return found by dividing the annual Net Operating Income by the purchase price). They’re saying you could get a 10% return if you did something (fill empty tenant spaces, raise rent to market rates upon lease renewals, cut expenses, etc.). It’s what might be achieved. It does not represent todays reality. Don’t rely on pro forma numbers. Dig a little deeper.

Solution: Use this claimed number with caution. Research the claim to see if it could hold up and to see what you would have to do to make it so. Do not blindly trust it. Never buy based on pro forma numbers.

These are just 3 of many important factors to look at when investing in real estate. Don’t let that scare you away. Once you learn the ins and outs of buying commercial properties it can be a very financially satisfying and fun business. Just remember it is a business. And that is a topic for another article.

Enjoy, and feel free to send me questions.

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That's it for this time. See you next week!

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