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Investors often look to real estate, especially commercial real estate, as a stable asset during uncertain market conditions. But, it’s important to note that commercial properties can be expensive. Before you jump into buying commercial real estate, you should be aware of the closing costs involved in finalizing the sale. This part of the blog will help you understand these costs so you’re prepared for what you need to pay at closing.
What is Considered Commercial Real Estate?
Understanding the closing costs for commercial real estate starts with knowing what qualifies as commercial property. Essentially, commercial real estate includes properties used for business purposes, which can generate income through rent or capital gains. This is different from residential real estate, which is primarily used for housing.
Commercial real estate covers a wide range of property types. Sometimes, even residential properties can be categorized as commercial real estate based on their zoning. Here are some common types of commercial properties:
- Retail stores and storefronts
- Strip malls
- Apartment buildings (especially larger complexes)
- Grocery stores
- Movie theaters
- Office buildings
- Warehouses
- Manufacturing facilities
- Restaurants
Flat-Fee Commercial Real Estate Closing Costs
When dealing with commercial real estate, there are some flat-fee closing costs that are pretty much the same for all types of investment properties. These costs include things like title insurance, property appraisals, environmental reports, as well as processing and underwriting fees, and credit checks.
Title Search and Insurance: $2,500 – $15,000
For a commercial property, you’ll need a title search to make sure there are no issues with the property’s title. Title insurance protects you in the rare case something does pop up. This insurance is often provided to multiple parties in a deal. You can expect to pay between $2,500 and $15,000 for this, and it’s usually part of your overall closing costs.
Appraisal Cost: $1,000 – $10,000
Getting an appraisal from an independent party is a must. This is especially true if you’re working with a federally regulated lender, but private lenders usually require it too. The cost can vary based on where the property is, what kind it is, and how big it is. Remember, if you’re buying multiple properties, you’ll need to pay for each appraisal.
Environmental Report Cost: $2,000 – $6,000+
You’ll also need an environmental report for both the land and the building. This usually comes in two parts. The first part, or Phase 1, costs between $2,000 and $6,000. If the property doesn’t pass this phase, you’ll need a Phase 2 report, which will add to the cost. It’s smart to budget for both, just in case. And if Phase 2 is needed, you might also have to pay for environmental cleanup, which can be expensive. However, sometimes these costs can be negotiated between the buyer and seller.
Processing/Underwriting Fees: $500 – $2,500
Lenders charge fees for processing and underwriting your loan. This covers the cost of their staff working on your loan application. These fees are often upfront and non-refundable.
Credit Checks: $100 – $1,000
Credit checks are necessary for every major player involved in the deal. The more investors you have, the more you’ll pay in credit check fees.
This section gives you a rundown of the flat-fee costs you’re likely to face when closing on commercial real estate. It’s important to budget for these to avoid any surprises at closing.
Value – and Size-Based Commercial Real Estate Closing Costs
When it comes to closing costs for commercial real estate, some are tied to the property’s value or size. These include origination points, fees for mortgage brokers, and property inspections.
Origination Points: 0 – 2+%
Lenders make money on loans through interest and origination points. The presence of origination points varies depending on the loan type and lender, so it’s important to shop around and understand all your options. Some lenders offer loans without any origination fees (“at par”), earning only from the interest. Banks and credit unions often charge origination fees ranging from 0.25 to 0.5 percent, while private lenders may charge 2 percent or more. These fees are calculated as a percentage of the loan amount.
Mortgage Broker’s Fees: 0 – 2%
If you work with a commercial mortgage broker or use a loan marketplace, you’ll have to pay broker fees. These fees can range from 0.5 to 1.0 percent, although some loan products may not have any fee. Despite the additional cost, using a broker can be valuable for the assistance and options they provide.
Inspection Costs: $0.03 – $0.10 per Sq Ft
An inspection is typically required by lenders to check the condition of the property. It’s a good idea to have one regardless to assess safety, security, and any necessary repairs. The cost for an inspection will vary based on the property type and size, generally falling between 3 to 10 cents per square foot.
Legal Costs for Commercial Property Closing
Finally, there are legal costs involved in purchasing commercial real estate. Both you and the lender will have separate legal fees, and usually, you’ll end up covering both sets of fees. There might also be other miscellaneous expenses.
Lender’s Legal Fees: Varies
The legal fees you’ll pay for the lender can differ a lot based on several factors. Things like the property’s size and location, how the deal is structured, and the attorney’s rates all play a part. These fees can range from a few thousand dollars for smaller loans from local lenders to over $15,000 for larger commercial mortgage-backed security (CMBS) loans.
Your Legal Fees: Varies
Your own legal fees will vary too, influenced by many of the same factors as the lender’s legal fees. Generally, your fees might be a bit lower since the lender is the one drafting the loan documents. However, you should still be ready to pay a significant amount for legal services.
Miscellaneous Expenses: Varies
Miscellaneous expenses in commercial real estate transactions can be small compared to other costs, but they’re still important. These could include paying for expert advice, unplanned trips to visit the property, or other unforeseen expenses during the due diligence process. It’s wise to have some funds set aside for these types of costs.
Overall Closing Costs on Commercial Real Estate Properties
On average, you can expect closing costs to be about 3% to 5% of the total property value for commercial real estate. The exact amount will depend on factors like the state where the property is located, any concessions made by the seller, repairs needed, and the specific fees we’ve discussed.
Remember, closing fees can vary widely, so both buyers and sellers should be prepared for these potential costs. When you’re applying for loans, make sure to factor in these closing fees as part of your total expenses.
Investing in the right commercial property is important, regardless of the closing costs. But if you find that these costs are on the higher side, consider the long-term financial benefits that commercial real estate offers to balance it out.
High Cash Flow from Commercial Real Estate
One of the biggest advantages of commercial real estate is its ability to generate high cash flow. Cash flow refers to the movement of money in and out of an asset. Commercial properties, with their high net cash flow, mean more money flowing back to you.
Rental income from commercial properties, such as offices or retail spaces, provides a steady stream of cash. Businesses, aiming to make a profit, are generally reliable tenants. They’re likely to pay their rent on time because it’s in their best interest to maintain a good rental space for their operations.
Appreciation of Commercial Properties
Another perk of commercial real estate is its tendency to appreciate over time. Real estate typically increases in value, partly because land is a limited resource. Developing new properties, especially commercial ones, is costly and time-consuming. This limited supply, combined with slow development rates, helps maintain the value and stability of commercial properties. As an owner, you can usually expect your property’s value to increase over time, making it a safe long-term investment.
Inflation Hedge with Commercial Real Estate
Commercial real estate also serves as a hedge against inflation. As costs rise due to inflation, so can the rent you charge, keeping your income in line with or ahead of inflation rates. This makes commercial properties a smart choice in a fluctuating economy, ensuring your investment remains valuable.
Reliable Tenants in Commercial Properties
Businesses make reliable tenants. They need to maintain their operations and are motivated to pay rent on time. As businesses grow and become more successful, they become even more secure and reliable tenants, contributing to a stable income from your property.
Tax Benefits for Commercial Property Owners
Owning commercial property comes with certain tax advantages. The government offers incentives like depreciation to make property ownership more appealing and profitable. These tax benefits can significantly enhance the profitability of owning commercial real estate.
Understanding the Hurdles in Commercial Property Ownership
While the benefits of owning commercial property are clear, it’s important to understand the initial barriers, like closing costs. Knowing these costs helps you determine if you’re financially ready to invest in this lucrative market.
The Bottom Line on Commercial Real Estate Closing Costs
Closing costs for commercial real estate might seem high, but the right property can quickly make up for these expenses. Investing in commercial real estate adds a valuable asset to your portfolio, potentially enhancing your long-term financial returns.
