When the market enters periods of uncertainty, investors turn to real estate as a way to buoy their finances with stable assets.
One of the most stable types of real estate you can acquire is commercial property. The trade-off is that it can get expensive. Before diving into commercial property, you need to account for the expenditures to finalize the sale.
Learn more about the closing costs here so you can expect how much you need to pay when you finalize.
What Counts as a Commercial Property?
To understand the factors that drive closing costs of commercial properties, it’s essential to understand what defines commercial property in the first place.
Commercial real estate is a property class zoned as a profit-earning asset. Whether through the generation of capital gains or rental income, commercial properties are most accurately identified by their ability to produce a profit.
Whereas residential properties are defined by their classification as units of housing, commercial properties have a much broader classification. In fact, residential properties are sometimes doubly classified as commercial properties depending on how they are zoned.
Here are a few examples of commercial property types:
- Strip malls
- Apartment buildings
- Grocery stores
- Office buildings
- Manufacturing buildings
What Are Closing Costs?
Real estate investors and aspiring property owners may be familiar with down payments, which are a percentage of the total property value paid upfront.
Closing costs are slightly more complicated. These varied expenses may be levied on the buyer or the seller of the property.
Putting a property on the market and getting an appraisal on its value are done by third parties to the sale, but the costs of these appraisals and inspections can fall on either line of buyer or seller responsibilities.
The final expenses generated by these parts of the real estate transaction are what constitute the closing costs. Depending on the sale, closing costs can vary.
What Fees Are Included in Closing Costs?
Various fees could factor into your closing costs. Some of the most common closing costs include:
- Application fee: This covers the processing costs for your loan application, including credit checks. Largely depends on the lender you choose and the time it takes to process your loan request.
- Appraisal fee: Covers a certified professional appraisal of the property. Appraisals are important for lenders to ensure that your loan amount is valid and that the property itself could cover the loan if you were to default. Appraisal fees reflect the complexity of the appraisal, and are not flat fees or connected to the value of the property.
- Attorney fee: The cost of an attorney. In some states, the presence of a real estate attorney is necessary for the closing to proceed. Attorney fees depend upon the amount of time the attorney works, as well as their rates.
- Courier fees: Covers the services required to send loan documents to the relevant parties for processing. Usually, a flat fee of about $20.
- Credit report fees: The amount it costs your lender to run your credit report. Usually, a flat fee is between $20 to $25.
- Escrow fees: Usually about 1% to 2% of the purchase price of the property, escrow fees often encompass other fees on this list (including real estate attorney fees, property taxes, origination fees, homeowners and title insurance premiums) as well as seller profit. The escrow fees are paid to the title or escrow company to set up the escrow account, covering the paperwork costs and the safe exchange of funds.
- Loan origination fees: The amount charged by a lender for preparing your loan, also referred to as administrative fees, processing fees, or underwriting fees. This fee is usually about 0.5% of the amount you’re borrowing, regardless of the loan size.
- Owner’s title insurance: Insurance in case of title problems or disputes once the property is in your name. Depending on where you live, either the buyer or the seller can be expected to pay for title insurance, which usually costs 0.5% to 1% of the purchase price.
- Prepaid interest charges: This covers the interest that accrues on a mortgage between the date of settlement and the due date of the first monthly payment. Nearly all lenders require prepaid interest, and the costs reflect the size of the loan taken out.
- Property taxes: Usually, buyers can expect to pay two months of city/local property taxes when they close.
- Rate lock fee: A fee charged by lenders to lock current interest rates for an extended period. The longer you wish to lock your interest rate, the higher the necessary deposit.
- Repairs: Properties often need repairs before or during a sale. Depending on the individual sale and the property’s condition, repair costs can vary, and either the buyer or seller may be responsible for paying.
- Transfer tax: Typically based on the property’s value, transfer taxes are state taxes levied when a property is transferred from one owner to another.
While not all of these costs may factor into closing costs, commercial property owners and aspiring commercial property owners should expect to pay at least some of these costs upon closing the sale of the property.
Real estate broker fees, inspection fees, and repairs are generally the most common fees that arise during the sale of a commercial property. Taxes levied from state and local governments on the sale can have a substantial impact as well.
Another prominent factor in closing sales for buyers is loan fees.
What Are Typical Closing Costs on Commercial Properties?
In total, anywhere from 3% to 5% of the total value of the property can be expected in additional closing fees, on average.
The final cost you pay when buying or selling a commercial property depends on the state where the sale is happening, the number of seller concessions agreed upon by the parties involved, the number of repairs required, and additional fees added in, as noted above.
As closing fees can vary to a wide degree, it is important for both prospective buyers and sellers to account for these margins. Be sure to account for the impact closing fees will have on your total expenses when applying for loans.
You’ll want to invest in the right commercial property, no matter how much you pay in closing costs. However, if your closing costs seem to be high, it’s essential to consider the financial benefits commercial real estate provides.
High Cash Flow
Cash flow describes the money going into and coming out of an asset. The higher the net cash flow an asset has, the more money there is finding its way back into your finances.
Real estate has a high cash flow. Rental properties have a potentially high, steady cash flow, and monthly rental income supplements the property owner with a reliable cash stream.
Commercial real estate, in particular, has an impressive cash flow. Tenants are businesses setting out to generate a profit, so commercial property owners can count on their business tenants to do their best to meet their rent as it’s also in their best interest to do so.
Real estate appreciates extremely well compared to other financial assets. Property often appreciates well by its very nature.
Real estate is inherently scarce. Land is a finite resource. Development of new property is time-consuming and costly, particularly for a commercial property. The scarcity of land, in addition to the slow pace of development, keeps the supply of commercial property low but stable.
The combination of these two factors stabilizes the value of commercial real estate as a whole, ensuring its steady increase in appreciation over time. Commercial real estate owners can confidently expect their assets to increase in value over time, with little likelihood of crashing.
Commercial property gives investors a key advantage: real estate works as a protective hedge against inflation. In the current economy, that’s not a bad thing. Property assets accomplish this sort of protective hedge function in two ways.
Firstly, the robust appreciation of real estate ensures that the asset’s value remains strong regardless of market trends. Real estate is among the most reliable long-term investments. There’s a reason why many people include real estate investments in their retirement plans.
Secondly, commercial real estate mitigates the effects of inflation by factoring operating costs into rent. Rental income progresses proportionally with inflation. When costs increase, so does rent, protecting property owners from ballooning prices.
Commercial properties have an advantage over residential properties in the reliability of their tenants. Rental properties are a great source of income, but complications can arise when tenants miss their rent, or worse when a tenant stops paying rent and needs to be evicted.
Tenants in commercial properties are businesses. No matter the business, the reason for its existence ultimately is to make a profit. Businesses make reliable tenants because it is in their self-interest to cover their operating expenses, which include their rent.
Successful businesses can grow, earning more profits and making them even more secure, reliable tenants.
Commercial property owners may have the opportunity to utilize key tax breaks to encourage growth for the property owner and tenant alike.
Property ownership can be an expensive and burdensome enterprise. To encourage participation in this complicated market, the government may incentivize commercial property owners with a number of tax benefits to alleviate the obstacles involved in property ownership.
Tax benefits like depreciation can be used to write off a great number of expenses to make commercial property ownership even more profitable. Unlike other assets, commercial property can work for the holder by providing critical tax breaks that increase their earning potential.
The benefits of commercial property ownership are clear. What are the hurdles to getting into commercial property ownership in the first place? Understanding what closing costs are will help you assess whether or not you’re financially situated to take on this lucrative enterprise.
The Bottom Line
Closing costs are not always cheap, but choosing the right property can help you recoup them in no time. Investing in the right commercial real estate can do just that — add a premium financial asset to your portfolio that can help increase your returns in the long run.
Are you interested in learning more about commercial real estate? Explore Loanbase’s Complete Guide to Real Estate Investing here.