Your Guide to Commercial Real Estate Investing
Commercial real estate investing can be a sound decision, with significant rates of return. But how do you determine that you have made the right decision investing in a property? First, you must perform your due diligence to understand the commercial property and uncover its existing risks fully.
Are you new to commercial real estate (CRE)? You’ve come to the right place. This guide will look at how commercial real estate investing works, its benefits, and what to look for in commercial property before getting started.
What Is Commercial Real Estate Investing?
Commercial real estate investing is the purchase of non-residential real estate to receive returns through the sale, lease, or self-utilization. The primary difference between this investment type and residential real estate is the valuation process. The former relies on capitalization rates and net operating incomes.
Types of CRE Asset Classes
An asset class is a category used to differentiate the various types of assets in commercial real estate. Each asset class consists of different property types, each with its own merits and risks. Below are the main types of CRE asset classes.
Multifamily
Multifamily properties consist of high-priority CRE that typically fall under classes A, B, C based on factors like location and state of the building. The common multifamily properties include:
- Garden apartments
- Senior and assisted living
- Mid- and high-rise apartments
- Student housing
Office space
Office spaces are another popular CRE asset class. While they can be costly, people love this investment opportunity owing to its diverse revenue streams and relatively low risk. Like multifamily, office buildings fall under categories A, B, C depending on the property’s features like location and age.
Retail
Retail properties are those that offer products and services. And while the pandemic-related ecommerce shift has somewhat led to its weakening, retail can be beneficial. For instance, they often carry long-term leases, providing more stable incomes. These properties include malls, community retail centers, and out parcels.
Industrial
Like retail, industrial properties are popular because of their long-term leases. The current business landscape has also favored this industry, increasing their demand exponentially. Industrial properties fall under various categories, including light assembly, flex industrial, heavy manufacturing, and bulk warehouse.
Special purpose
Special purpose real estate typically refers to those buildings meant for a specific group or purpose. Moreover, the valuation process for such facilities isn’t straightforward. They include theaters, amusement parks, and schools.
Benefits of Commercial Real Estate Investing
CRE investment has the following benefits.
- It offers commercial real estate investors the chance to gain better capitalization rates.
- CRE opens up other investment opportunities besides housing, for instance, warehouse.
- Commercial real estate investing is more stable as it is less affected by market fluctuations than traditional investment.
- Special purpose CRE in strategic areas guarantees consistent cash flows from rentals, thereby providing passive income.
How Does One Get into Commercial Real Estate Investing?
While it is possible to invest in commercial real estate individually, the cost of doing so is relatively high. Plus, you may need professional property management to protect your investment. Experts recommend two commercial investments options.
- Real estate investment trusts (REITs) combine resources from multiple investors. Doing so lets you receive dividends without having to get involved in the management of financial processes. The REIT model typically works like this: the company leases properties and distributes the rental income to each member according to their investment.
- Fractional ownership – Fractional ownership is where the members split the cost of owning the property. This investment type is often common for costly assets like vacation properties or aircraft. Each owner earns an income from rental proceeds. Plus, for this arrangement, it’s best to hire a property management company for maintenance.
The lease period for these investments typically ranges anywhere from three to ten years. Additionally, these net leases will fall under any of the following CRE types.
- Single-net lease – Here, the tenant covers both rent and property tax.
- Double-net lease – For this lease type, the landlord is responsible for repairs while the tenant covers repairs and insurance.
- Triple-net lease – Here, the tenant is responsible for insurance, maintenance, and property tax.
- Gross lease – For a gross lease, the landlord covers all expenses except base rent.
What To Look for in Commercial Property Before Investing
Now that you understand how CRE works, here are the most important factors to consider before jumping into the real estate market.
Location
Location is perhaps the most decisive factor for how your commercial investment will perform. Remember, for valuation, the accessibility of highways and transport hubs and the proximity to markets will impart your investment.
What to look for
The main thing to examine here is the utilization of the surrounding real estate investments. So, if the rental building is next to an open piece of land, it would be wise to find out what the owners intend to build there. For instance, an industrial facility could significantly diminish your property’s value. The best way to get this information is through the town hall or local institutions responsible for zoning.
Property condition
The state of the desired commercial property also matters. For instance, new buildings come with attractive pricing, modern amenities, and flexibility. However, you will likely experience high costs, delays and must also deal with the unknowns of a developing neighborhood. On the other hand, existing properties are convenient as they already have established amenities hence fewer costs.
What to look for
Here are a few things to help you decide whether an existing or new construction will be a sound investment decision:
- The quality of fixed items like furniture and equipment that are part of the sale.
- The previous projects and reputation of the prospective construction company.
- Commercial property costs, including maintenance, property taxes, and outstanding fees.
- The leasing types
Valuation
A property valuation examines the factors mentioned earlier, including condition, classification, and location. The process is necessary to ensure each party involved in making the deal gets the best price. Moreover, valuation helps you command the correct rent and leasing figures will cover liabilities.
What to look for
- Expected cash flows if you plan to invest in rental properties.
- Construction expenses excluding the depreciation costs.
- Comparable sales of buildings with similar features.
Property utilization
Understanding how you intend to utilize the commercial property will guide you into choosing the suitable investment model for you.
What to look for
Determine which of the following investment utilization plans makes financial sense.
- Buy property, then sell (short-term). This plan offers quick and moderate profits.
- Self-use – Utilizing a commercial property helps you save rent and also offers appreciation benefits.
- Sell (long-term) -This investment plan is ideal for life-long plans like retirement.
- Lease – This investment plan provides consistent returns.
Real estate market
CRE does not experience fluctuations like other investment types. However, market shifts do affect the vacancy rates and stability of tenancy. For instance, because of COVID-19, asset classes like office spaces suffered declines in occupancy.
What to look for
Assessing the asset’s performance in the present economy could help you determine whether the property is right for you. Some things to keep an eye on include:
- Mortgage rates
- Foreclosures
- State of the real estate market (buyer’s/sellers)
- Inventory
Working With a Commercial Real Estate Agent
Commercial real estate investing can offer consistent cash flows, complement lifelong goals, and, in some cases, tax advantages. Reaping such benefits is only possible when you understand how the real estate market works, plus when you perform due diligence to avoid unexpected financial consequences.
For the above reasons, it is prudent to work with a commercial real estate agent that understands the market dynamics, networks, and overall expertise. Anthony Maccaroni offers a wide array of commercial real estate services, from marketing analyses to property valuations. Are you looking to invest in hotel and motel real estate in Pinellas County, FL? Contact us at (727) 641-0271 for expert commercial real estate services and to schedule a free consultation.