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Striking the Balance: Assessing the Right Amount of Leverage to Maximize Return on Your Commercial Property

Learn the benefits (and perils) of putting leverage to work for you with this basic primer

Leverage is an incredibly important part of most real estate transactions. However, as we saw during the catastrophe a decade ago, too much of a good thing can be a recipe for disaster. It’s essential for real estate investors to intimately understand how leverage works, the benefits and shortcomings of using it, and the amount necessary to produce an optimal return.

What exactly is leverage?

In this context, leverage is simply the amount of financing that exists on a property compared to its market value at any given time. In a straightforward real estate deal, a fixed mortgage may represent all leverage involved, but in more complicated transactions, it can include a variety of different debt layers, such as first and second mortgages, some type of mezzanine financing, or capital stack.

The primary benefits of leverage

Real estate investors use leverage as a way to increase the return of an investment and lower capital outlays. It is primarily employed when the debt cost, such as a mortgage, is cheaper for an investor than the unleveraged returns a property can generate. By upping the proportion of financing, buyers can take any additional profit on the deal and apply it to the remaining equity to further boost leveraged returns.

The dangers

In the real estate market, values can change – quickly, in rare circumstances (remember 2006?). When prices are climbing, the amount of leverage in a deal isn’t much of an issue, but as they begin to fall, owners can end up owing more to backers than a property is actually worth. For investors, this can mean the simple inconvenience of reduced profits, or disastrous losses in a market that changes swiftly. And if rents in an area fall as well, investors could be looking at a scenario where they cannot afford to hold a certain property.

Use only the amount of leverage that you can live with

While some home buyers may not think about financing in terms of “leverage,” most are using this basic investment tool to purchase residences. They pay off the value of the home over the course of several decades while enjoying the property, and it gives them access to real estate that would otherwise be unobtainable without bringing significant capital to the table.

In the commercial arena, leverage is a more complex, finely-tuned instrument for improving returns on property holdings. Of course, the risk occurs when property owners borrow too much and if any type of downturn occurs, they will immediately see negative returns on their investment. Striking the balance with the right proportion of leverage is essential in both residential and commercial transactions, but a comprehensive assessment of a commercial deal involves reliably calculating both the income that will be generated from the property’s use (i.e., its rental income) and its conservatively-projected value.

If you’re interested in learning more about the power of leverage, and how to use it sensibly to grow your real estate investment portfolio, reach out to Morris Southeast Group. We are veteran commercial real estate agents who have been serving Miami-Dade, Broward, and Palm Beach counties for decades. Contact our team by phone at 954.474.1776, reach Ken Morris on his cell at 954.240.4400, or email kenmorris@morrissegroup.com.

7 Hazards to Avoid in a Commercial Real Estate Transaction

Top issues to look out for when negotiating on commercial real estate property

If you’re considering the purchase of a commercial property, there are a number of key factors that you should think about before signing any type of offer or sales agreement. Commercial real estate transactions are often much more complex than residential deals, and it’s important to ensure that you’re sufficiently prepared, as well as properly represented, during the entire process.

In this blog, we outline a variety of hazards that may occur in a commercial deal. One way to avoid many of these hurdles is to partner with a real estate firm that will look out for your best interests, such as Morris Southeast Group.

Potential hazards to avoid when purchasing a commercial property

1. Survey issues: Ordering a survey immediately after the sales contract is signed allows you to determine if there are any issues due to encroachments or easements that could present problems in the future.

2. Title concerns: Your attorney should order a title search as soon as possible after the sales contract is signed. Concerns that could be unearthed due to a search include liens, mortgages, probate issues, assessments or judgments against the property, foreclosures, or even pending lawsuits. While the sales contract will typically provide the purchaser with a title review period, it should coincide with the due diligence period to offer the most flexibility for the buyer

3. Zoning restrictions: Do current zoning restrictions allow you to use the property as you intend, and what are the zoning requirements for any adjacent properties? You can request a zoning verification letter from your local municipality to receive information about the legal usage for a given location. If there are any concerns regarding a specific use for the property you are considering, it would be optimal to conduct initial research before submitting a contract offer, as zoning matters usually take months to resolve even if there is a solution available to re-classify its use.

4. Building maintenance issues: Are there any issues with the roof, electrical, plumbing, HVAC, fire sprinklers, or elevator? Make sure to obtain an-in depth property condition assessment to ensure that any deficiencies are found and repairs are handled or resolved prior to closing.

5. Environmental concerns: Are there any environmental issues related to the property you are purchasing? It’s recommended that you obtain what is called a Phase I environmental assessment, and based on these findings, a Phase II environmental assessment could be necessary to isolate any concerns with the property.

6. Tenants: Does the building that you’re purchasing currently have tenants? If so, it’s important to properly review each lease agreement to determine the obligations of both the tenant and you, the new landlord.

7. Property title details: How do you plan to take title to the property? This should be decided usually before you make an offer to purchase and definitely before you close, as it can help to avoid additional costs afterward, such as legal fees and complex tax implications.

8. Financing: If you are going to require financing for the purchase of the asset (as most investors take advantage of the capital markets), it is important to obtain several proposals from various lenders, including banks, insurance companies, and even non-traditional sources of financing. The terms can vary widely and can greatly affect the overall rate of return that you receive from the investment.

Partner with Morris Southeast Group to stay informed throughout a commercial real estate transaction

As a commercial real estate investor, you will not have many of the protections when searching for a property that are afforded to residential buyers in Florida. For this reason, you should consider working with an experienced and savvy commercial real estate broker and consultant who has represented buyers and sellers in South Florida for decades.

Ken Morris of Morris Southeast Group has the experience you need in the top South Florida markets, including Miami-Dade, Broward, and Palm Beach Counties. For more information on our commercial real estate services, don’t hesitate to reach out to our team today by phone at 954.474.1776, reach Ken Morris on his cell at 954.240.4400, or email kenmorris@morrissegroup.com.

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