What’s the real cost of a real estate downpayment?

As you’ve read here a number of times, buying commercial real estate is a great way to build generational wealth. It’s like a jelly of the month club. By that, I mean the gift that keeps on giving!

Many who read this column have founded an enterprise housed in a parcel of commercial real estate which they also own. So, the occupying company earns income through its business operation and pays rent for use of the building. Company value increases over time and the address appreciates. A double whammy!

Southern California has countless entrepreneurial stories whereby a generation took a risk, formed a company, bought a location and succeeding family members benefited. I have the privilege of counseling these family-owned and operated manufacturing and logistics businesses.

Recently, a conversation struck me as particularly column-worthy. Specifically, how much should be allocated for a down payment when considering a buy? The easy answer is 10% of the purchase price if leveraged through the Small Business Administration and 20-30% when financed conventionally. Boom. Done. See y’all next week.

But, wait, there’s more … substantially more to the story of originating a loan. So, please stay tuned for a minute more.

In addition to the 10-30%, suggested would be to budget for the following:

Appraisal: Regardless of your lender choice – SBA, bank, insurance company, or hard money – an appraisal will be completed. Contained within the bank’s underwriting is a confirmation the price paid is in line with the market. Plan on $2,500-$5,000 for this review.

Environmental: Lurking beneath the surface of your purchase could be a problem. These unseen issues are caused by something toxic deposited in the soil. A review of the previous occupants in the building, messy neighbors, and the smokestack down the street combined with a look at old aerial photos – forms what is known as a phase I environmental report.

Generally, this does the trick and provides a clean bill of health. If environmental concerns rise – such as stained concrete or containers of waste – a phase two will be employed. Soil borings are sampled and tested. Recommendations range from no further action to remediation.

Have you ever seen a pile of dirt inside yellow tape next to a gas pump at your local station? No. It’s not an episode of CSI. Aeration is one way to get the bad stuff out of the soil. Plan on $2,500 for subsequent phases if remediation is required.

Legal: You’re going to want an attorney to review the purchase agreement, title commitment, and draw your LLC formation documents. Budget around $10,000.

Escrow and title: Sure, the seller pays for a standard policy but any lender policies or extended coverage are yours to bear. Plus, you’ll pay half of the escrow fees. Another $10,000, but that’s dependent upon deal size.

Survey: This is not always necessary unless you’re after an extended policy of title insurance. Unrecorded easements, abandoned driveways, and recorded leases are typically not covered with a standard policy. Utility locations, property lines, and underground pipes are clearly mapped as well. $5000 is reasonable.

Loan points: In addition to the interest payments due over the term of your debt, you’ll pay a percentage of your loan amount to the bank. 1-2% is pretty typical.

Cost segregation: One of the really cool things about owning commercial real estate is the depreciation that lowers your income tax burden. The improved portion of your parcel – the buildings – can be depreciated over 39 years on a straight line — 1/39th each year. But other components of the improvements such as walls, doors, glass and air conditioning have a shorter useful life, and if properly segregated, can be written off sooner. Usually, your CPA can help with this. She’ll want to be paid, though. $15,000 seems fair.

Once you become the owner, gather and total your receipts. Add all you spent to the 10-30% down payment. What results is the “true” investment into your buy.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.