The Economic Downturn and Real Estate Investing
Despite the recent financial turmoil that Americans have been faced with, and near collapse of real estate and real estate investing, there are bargains to be had that are both easy to own and maintain, and can provide some positive cash flow. Real estate investing has taken a bad rap due to all of the speculation that built up and cheap money available to people who had no business investing in real estate. When the economy fell, many people were left unable to pay for investment homes, and the number of foreclosures skyrocketed. It wasn’t just house-flippers and newly minted landlords who suffered. Commercial real estate investors were hit hard.
Why Standard Commercial Properties Were Hit Hardest
When you think of commercial properties, what do you generally envision? You probably think of big money investors, often investing with multiple partners, buying up large parcels of land and building a big box retailer, right? Later, when the retailer goes bankrupt, or finds a better location further out in the suburbs, the commercial property investors are saddled with an empty building that they can’t get rid of for anything.
Commercial real estate suffered so much in this economic downturn because of the way it is typically financed. A commercial real estate loan is a business loan, and typically amortized over 10, 15, 20, or 30 years, similar to a residential mortgage, with a key difference. A commercial mortgage almost always has a balloon payment due after 3 or 5 years. So, an investor takes out a loan for $1,000,000 at 6%, makes payments of roughly $6,000 per month, with about $5,000 of that going towards interest, and then after 5 years, still owes $930,000, which he or she has to then either pay off or refinance.
The problem is, due to the downturn, commercial properties fell in value just like home values did. Unlike homeowners who are underwater, that is, owing more on their homes than they are worth, who can choose to ride out the downturn in the hopes that their homes will appreciate in value, a commercial property owner has to either get a new mortgage or pay off the loan when the balloon payment is due. A business owner, whose building is worth less than the balloon payment, can’t refinance at ANY rate. He or she is left at the mercy of the lender or risk losing the property.
Why Small Town Real Estate Is Better
Perhaps you’ve seen them while driving in the country, or certainly on television. Small towns in Middle America, reminiscent of Norman Rockwell scenes of Christmas tree lightings and ice skating in the town pond, do exist. Many of these small towns still have vibrant town squares in which people dine, shop, and conduct business. These are the types of towns that you need to focus on for investment opportunities.
The primary reason is that small town commercial properties are much cheaper than their urban counterparts. Pick a building valued at $100,000, located in Harlan, Iowa, a county seat of Shelby County with a population of 4,871 in 2009 according to city-data, and over 12,131 in the county according to Google Public Data, and a comparable property 60 miles away in Omaha, Nebraska could fetch nearly half a million dollars. As property values in small towns didn’t soar like those in larger cities, they didn’t fall much either. When rented, rents can more than cover expenses, and it’s much easier for an individual investor to finance a 100,000 purchase than larger amounts. Maintenance on town square buildings, particularly ones in the middle of a row block, are structurally supported by their neighbors and quite protected from the elements. And, in many small towns, historic status has been given to some of these buildings, which possibly means restoration tax credits when the time comes to repair or restore the building.
What to Look for
Unless you have inside knowledge of a major employer coming into town, look for towns with almost no (5% or less) vacant storefronts, as this is indicative of a thriving business district. A Wal-Mart in town or in a nearby town isn’t necessarily a bad thing, particularly if the Wal-Mart is already well-established, as Mark Henricks writes in his The Myth of the Wal-Mart Effect, businesses that compete directly with Wal-Mart will usually fail soon after one opens (2010). Those that are left have either found a niche not offered by Wal-Mart, or offer a service that is valued by the community (2010).
Property that is directly across from a government administration building or courthouse will tend to do better than those that are outside of major traffic flow, as these are draws for people within the county to do business. Many of these buildings will have an upstairs, and depending on the condition, this could be rented out as additional office space, apartments, or storage, or could be renovated to fit one of these. Middle properties of row blocks usually require less maintenance, as you will primarily only have to care for the front and back of the building, in addition to the roof and foundation. As always, have a thorough inspection done on any prospective property so you’ll know what items may need to be taken care of immediately and what may be lurking down the road. Also, look for potential nuisance properties immediately adjacent to a prospective commercial property. A bar may be a great place to hang out, but you don’t necessarily want to own a property next to one!
Choose carefully and then Run it like a Business
When you’ve found the perfect small town commercial real estate property, negotiate the terms you want and buy it. If vacant, place ads and market your available property to prospective tenants. When you get tenants, keep records of all communication and treat it like a business. Your costs should be low, and rents can easily cover your low mortgage payments and property taxes, and bring positive cash flow. Enjoy the money, and your little slice of Americana.
Harlan, IA. (2009). City-Data.
Henricks, Mark. (2010). The Myth of the Wal-Mart Effect. BNET.
Shelby County, IA Population (2008). Google Public Data.