Net Income Investments

There are various ways to invest in commercial real estate. The most risk free is the purchase of an income producing property. An income producing property is one in which the user and the owner are separate entities. For example, many national pharmacy and fast food chains are owned by an investor or developer and leased to the pharmacy or fast food chain.
The reason a business would lease the property rather than own it is to keep their capital to operate and expand their business rather than tie it up in real estate. Leases and related expenses are 100% deductible business expenses and do not impact a business's availability of capital.
At times when a business needs to raise capital and owns real estate, it will sell the real estate to a net income investor and lease it back. Banks have done this recently.

Commercial real estate loans require a cash down payment. An early question should be will this investment in commercial real estate provide me with a competitive return on the cash portion of this investment( e.g 20% down payment). vs. mutual funds, individual securities etc. As with other investments, the risk to get this return should be assessed and accepted.

Factors in assessing the risk are as follows:

1.Financial strength of the tenant. If a tenant is not financially strong and the business is not doing well, there may be problems with collecting the rent in a timely manner.

2. The net return after expenses. Is there enough left after expenses to cover mortgage payments and to provide a competitive return.

3.Length of the lease. Options to renew and likelihood of the tenant to renew the lease are critically important. The longer the lease the better as long as the lease rates stay competitive.
The lease payments are use to meet mortgage payments and for other reasons, living expenses, business expenses etc. If a tenant leaves, the bank still has to be paid and the bills keep coming. If the lease is too long; there might not be enough rent in the future to cover expenses or to demand a competitive sales price if selling.
An interview with the tenant/s is often an important due diligence requirement prior to sale. Often financing terms are better with longer leases.

4. Number of tenants. One good tenant with a high credit rating and a lease which has competitive increases in the rent and a good prognosis to remain and pays the rent 10 days in advance is the ideal which of course is rare. One tenant is the easiest to service but if they leave, there is the no rent period.
Multiple tenants are more difficult to service but if one leaves, there is still cash flow.
Both scenarios have pros and cons and have to weighed separately.

5.The potential to lease when a tenant leaves. What is the property like now. Ownership requires that it be kept up to keep the current tenant and to be attractive to new tenants. Also, leases must be kept up to remain competitive.

6. Exit strategy - When do want to get out of the deal and what do you want to do with the money. Currently if the property is held for a year or more, the profits receive capital gains treatment. The property can also be sold and exchanged into another property on a tax favorable basis.

7.How will depreciation and tax write offs impact my overall financial situation?
These are important advantages of commercial real estate investments and their consideration should play role in the decision.

If these factors are evaluated, you will be able to determine whether or not a commercial real estate investment should be part of your portfolio.