If you’re a business owner looking to have more control over your costs, you want to build up your equity in the years to come, or you like the idea of using real estate as a means of forced savings, buying the space where you do business may be right for you.
But purchasing commercial real estate isn’t the same as buying a residential home. There are different costs, requirements and paperwork to consider. In a recent conversation, Rod Hunt, Managing Director, Real Estate Lending at RBC, explains some of the key things small business owners should be aware of before buying a commercial property.
1. The space you want to buy may come with other units – and the responsibilities that go with it
While some business premises are stand-alone structures, many are not. “If you’re not buying a free-standing building, you may end up with other commercial units, tenants and the costs that go with that,” cautions Hunt. “Or, you may have two apartments upstairs to rent out.”
In addition to the responsibility of managing tenants and ensuring occupancy of other spaces, a commercial property with multiple units will typically cost more to maintain. For example, if you need a new roof, it will likely be a bigger and more complicated job than you’re used to. Instead of having to just pave your driveway, you’ll need to take on the whole parking lot. The complexity that comes with a bigger, multi-use space will have to factor into your decision.
2. You’ll need a commercial appraisal
While you may be familiar with a residential home appraisal, a commercial appraisal is much more in-depth, as the fundamental way that commercial real estate is valued is different. “Commercial real estate is valued on the basis of a capitalization rate,” says Hunt. This is the rate of return that is expected to be generated on a real estate investment property. “In addition to the income approach, the appraisal also considers the replacement cost. “A commercial appraisal is a large, lengthy document and far more detailed than its residential counterpart – therefore the cost is much higher,” adds Hunt.
3. You may also need a building condition report
Depending on the age of the building you’re looking to buy, a building condition report may be required to get approved for a commercial mortgage. Similar to a residential home inspection – but much more comprehensive – a building commercial report involves having an outside firm inspect the property. They do an in-depth study to ensure that the property is in good condition, to identify any maintenance that’s required and estimate the associated costs. “Lenders need to know that the building is in good shape before approving a mortgage,” says Hunt.
4. A full environmental report might be needed
Depending on the industry you’re in, you may need to arrange for a full environmental report. In fact, this step might even apply if the previous owner or tenant ran a business that might have affected the environment. “For instance,” says Hunt, if a former owner or tenant was a dry cleaner, an environmental inspection may be required to ensure chemicals haven’t leeched into the soil. Or if there is a gas station next door, your lender will need to be confident there is no oil or petroleum in the soil, toxic ground water, etc.”
5. Legal fees are higher
Finally, while putting together a residential mortgage is fairly straightforward, a commercial mortgage is considerably more complicated – the legal fees are therefore higher.
If you’re seriously considering buying your business premises, be sure to have a solid understanding of the costs and processes involved before you make your decision. You’ll also want to have a firm grasp of the future needs of your business. Will you need more space as your business grows? Will the down payment of the property interfere with your ability to invest in your company? Can you take on the extra responsibility of managing other tenants?
As you weigh your decision, think about these questions and the points above so you’re setting your business up for success – and not surprised by extra work and expenses you hadn’t planned for.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.