The Hazards of Value-Add Commercial Real Estate Investments

The appeal of investing in value-add commercial real estate is the opportunity it affords to build wealth faster than when one acquires a fully stabilized commercial real estate investment. Do you predict that you will eventually be able to sell a property to a developer for a big profit while enjoying the income of the current tenancy? Have you identified an older property in an up-and-coming neighborhood that could be repositioned following a renovation and re-tenanted? It's fun to think about the potential profit but what are the downsides to consider? Of course, these issues can arise even when you think you are purchasing a fully stabilized property. Let's talk through of the consequences of investing in commercial real estate so that you can decide if you are willing to take on the risks. A few points for your consideration:

How much free time do you have? Adding value to a real estate investment often requires a big time investment from overseeing construction to marketing a property with vacancies to the public and conducting property tours. When a building become vacant, it needs a different insurance policy. Coordinating locksmiths, re-assigning utility bills and the like can be tedious.
How much extra cash do you have on hand? It's easy when buildings are occupied and tenants are paying rent. But when you have a vacancy to fill, you are often opening pandora's box: if the landlord's or tenant's work needs a building permit, will that require new ADA-compliant restrooms; a new HVAC system? These items alone can cost tens of thousands of dollars for a small space. Have you financed the acquisition and will you be making loan payments with no income coming in?
How is the quality of the building's tenants? A value-add real estate investment opportunity often means there is room for improvement with the tenants' creditworthiness. Will the guarantors file for personal bankruptcy and effectively render the personal guarantee worthless? Will the tenant repeatedly default on the terms of their lease requiring expensive legal intervention? Will the tenant wreck the building after moving out causing more damage than their security deposit will cover?

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How much free time do you have? Adding value to a real estate investment often requires a big time investment from overseeing construction to marketing a property with vacancies to the public and conducting property tours. When a building become vacant, it needs a different insurance policy. Coordinating locksmiths, re-assigning utility bills and the like can be tedious.
How much extra cash do you have on hand? It's easy when buildings are occupied and tenants are paying rent. But when you have a vacancy to fill, you are often opening pandora's box: if the landlord's or tenant's work needs a building permit, will that require new ADA-compliant restrooms; a new HVAC system? These items alone can cost tens of thousands of dollars for a small space. Have you financed the acquisition and will you be making loan payments with no income coming in?
How is the quality of the building's tenants? A value-add real estate investment opportunity often means there is room for improvement with the tenants' creditworthiness. Will the guarantors file for personal bankruptcy and effectively render the personal guarantee worthless? Will the tenant repeatedly default on the terms of their lease requiring expensive legal intervention? Will the tenant wreck the building after moving out causing more damage than their security deposit will cover?

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