Commercial Property Danger Investors Should Avoid

Q: Gerald, my business partner and I are looking at a commercial property we want to buy.  The cap rate for similar properties in this area is about 4% and this property yields almost 6% so we’re going to jump on it.  Any last minute tips you can offer me? Robert, Short Hills, NJ

A: Robert, first kudos to you for spending the time and effort to do your due diligence, because the numbers are critical for an investment property.

The one concern I have regarding your potential investment is your debt service–in other words, how you are planning to finance the purchase.  If you’re paying cash, I’m not as concerned, but if you are borrowing money to purchase this commercial property  you have to be concerned about negative leverage which happens when the interest rate on the money you borrow exceeds the capitalization rate that the property yields.

Generally speaking, you ideally want the cap rate of the property to exceed the interest rate on the money you borrow by 2-3% or more as a cushion (the bigger the positive spread the better)–otherwise, you’re effectively losing money or are very close to losing money every month which is not an ideal situation for you as an investor.

Thanks for your question, Robert.  Good luck.

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