How to get started in Commercial Real Estate Investing
Real estate investing is a fantastic strategy to increase wealth. Particularly commercial real estate investing is renowned for offering some of the biggest revenue sources. This tutorial will explain all you need to know to get started if you’ve been investing in residential real estate for a while and are curious about how to do so in commercial property.
Disclosure: This article was paraphrased from another article on Fortune Builders and repurposed for educational use. It’s designed to encourage people to seek professional financial advice through our short Finance Quiz. You can access the original article link at the bottom of this page.
2022 Trends in Commercial Real Estate Investing
The COVID-19 epidemic has had a significant negative impact on commercial real estate assets such as offices, hotels, retail establishments, and others. Even if the epidemic is still going on, commercial real estate is predicted to maintain an economic recovery trend in the coming year. As the market continues to evolve, many commercial real estate investors are upbeat.
Although 2021 did not begin with a promising outlook, experts predicted that by the year’s end, commercial real estate will stabilize. Commercial real estate investors intended to cut expenses by about 25% in 2021, according to Kathy Feucht, global real estate head at Deloitte. Over the past year, there have been a lot of surprises, including a spike in the demand for industrial properties.
According to Julian Goldie, CEO of Goldie Agency, “more quants are expected to enter the market this year given the promise for outsized gains, stable yields, volatility hedges, and unique tax benefits. The post-Covid bounce and infrastructure expenditure are creating tailwinds for the market, and astute investors should take note.
In light of this, there are a number of trends that, depending on the kind of commercial real estate investment, are expected to emerge in 2022. Let’s examine how these various qualities are predicted to function:
• Retail Stores: As the economy adjusted to quarantines and high COVID-19 transmission rates in 2020 and 2021, a number of retail and department stores went out of business. Up to 25% fewer retail establishments are expected to exist by 2025 as people increasingly purchase online. Healthcare, grocery, and other alternative stores are predicted to take the role of retail establishments in urban locations like New York and San Francisco.
• Offices: As more businesses adopt work-from-home practices, the demand for office space could be permanently reduced by 15%, according to CBRE. As a result, the supply of office buildings will keep growing. However, during the past year, “hybrid” office practices have begun to appear, forcing employees to report to work only on specific days of the week. As organizations seek ways to preserve certain in-person workdays, this trend may stabilize office spaces.
• Hotels: Despite some loosened travel regulations, hotels are expected to struggle throughout the upcoming year. Many won’t start to improve until 2023, and expensive lodgings with traveler amenities won’t start to stable until 2025. Hotels in larger cities would be most affected as guests try to avoid staying in densely populated locations.
• Warehouses: Of all commercial real estate investments, warehouses are predicted to do the best. Their success is a result of businesses’ efforts to meet the escalating demand for e-commerce orders. 250 million additional square feet of warehouse space are expected to be needed, according to real estate specialists, in 2021.
• Apartments: At first, it was thought that apartments would struggle during the epidemic since many tenants wouldn’t be able to pay their rent. However, multifamily complexes are doing well since there is still a high need for homes. They are anticipated to be steady in the upcoming year thanks to record low interest rates and more affordable residences.
• Upgrades to rental properties: As renters get used to working from home, multifamily property owners may see an increase in requests for larger apartments. In competitive markets throughout 2022, upgraded units may also become more sought-after as renters look to upgrade their living conditions.
• Commercial Development: As housing markets around the nation work to satisfy rising housing demand, more new development projects are anticipated. Commercial developers with experience working on new construction projects may have little trouble finding opportunities in the coming year.
Commercial Real Estate Qualifications
Property that is frequently rented out for commercial and retail uses is known as commercial real estate. Purchasing or developing real estate that has been planned to house commercial tenants is considered investing in commercial real estate. Commercial real estate investors lease out and collect rent from the businesses that occupy their premises as opposed to from residential tenants, unlike residential real estate investors. It should be emphasized that this term includes raw land purchases made for commercial property developments. Five primary types of commercial properties may generally be distinguished. To find out more about each one, keep reading.
Five Kinds of Commercial Real Estate
It’s critical to comprehend the many sorts of commercial properties before diving into the specifics of how to invest in commercial real estate. In this manner, you can begin to consider the kind of business asset in which you want to specialize. Despite having a wide range of uses, commercial properties are typically divided into the following types:
5. Special Purpose
Retail buildings are another well-liked kind of commercial real estate. These establishments, which range from banks and eateries to strip malls and neighborhood shopping centers, are frequently found in populated locations. These real estate holdings range in size from 5,000 square feet to 350,000 square feet.
Office space is the most prevalent sort of commercial real estate. These structures can be classified as Class A, Class B, or Class C, and can range from single-tenant offices to skyscrapers.
• Class A commercial real estate often consists of recently constructed or completely refurbished structures in prime locations with quick access to important facilities. They are often managed by reputable real estate management firms.
• Older structures requiring capital expenditure are frequently seen in class B commercial real estate assets. These properties need only minimal repairs and improvements despite being well-maintained and managed, making them a favorite among investors.
• Properties in the class C of commercial real estate are frequently used for redevelopment opportunities. They typically have bad locations, need significant capital improvements to outdated infrastructure, and have significantly greater vacancy rates than buildings of a better class.
Apartment buildings, high-rise condominiums, and smaller multifamily units make up multifamily properties. When a piece of property contains more than one unit, it qualifies as multifamily real estate; however, if it has more than four units, it can also be categorized as commercial property. By moving into larger multifamily properties, many residential investors build upon their foundation in commercial properties. Tenant turnover is a factor that needs to be taken into account because residential renters often have shorter lease terms than office and retail tenants.
Industrial buildings, which include everything from warehouses to sizable manufacturing facilities, are often designed with manufacturing sectors in mind because they provide spaces with height requirements and docking accessibility. Additionally, these commercial properties typically offer additional chances for investment.
5. Special Purpose
Special purpose properties are typically created with a certain application in mind, making it challenging to repurpose them for another. Schools, self-storage facilities, and car washes are a few examples of properties with a specific use. Additionally, a significant share of real estate used for special purposes is related to the leisure and tourism sectors. Hotels, airports, sports arenas, and amusement parks are typical examples in the sector.
In the commercial real estate market, mixed-use development properties are also common and in demand. These properties display a variety of purposes, including residential, retail, and even public use. A building with mixed uses might feature retail and services on the ground floor and apartments on the upper floors. Discover why mixed-use developments have grown so popular in recent years by reading our guide to them.
What Is Commercial Real Estate That Is Owner Occupied?
Owner-occupied commercial real estate (OOCRE) refers to investments made by individuals who intend to occupy the property themselves. Any of the five forms of commercial real estate that were previously covered can be approached using this tactic.
One of the numerous advantages of business investing is the possibility of occupying the commercial property you invest in. Discover some of the other advantages that can catch your attention as you continue reading.
The Many Advantages Of Investing In Commercial Real Estate
Commercial real estate investing has the potential to be incredibly lucrative on both a personal and financial level. A common reason for investing in commercial real estate is to increase one’s wealth and security; however, additional reasons include tax advantages and the diversification of one’s investment portfolio.
The following advantages are also available to commercial redevelopers:
• Larger Income: A higher prospective income is the standout advantage of investing in commercial real estate. Single-family homes often sell for between one and four percent of their original cost, whereas commercial properties typically yield between six and twelve percent. Second, because properties often have more available units, commercial real estate offers a smaller vacancy risk. Consider that one vacant office space in a building with 25 commercial spaces will have a greater negative effect on an investor’s bottom line than one vacant duplex. Additionally, the length of business leases is typically greater than that of residential real estate. This implies that owners of commercial real estate deal with far less tenant turnover.
• Cash Flow: Due to lengthier lease terms, commercial real estate has one very significant advantage: a generally steady stream of income. Commercial buildings frequently have more units than residential properties, so you may double your income streams much more quickly and take advantage of economies of scale. Many commercial tenants additionally pay the building’s real estate taxes, property insurance, and maintenance expenses, which increases your owner benefits. This type of lease is known in the industry as a triple net lease.
• Less Rivalry: Commercial real estate also has the benefit of having comparatively little competition. Commercial investing is thought to be more challenging than other types of investing, hence there are less other investors in this market.
• Longer Leases: One of the most appealing aspects of commercial real estate may be the leasing agreements. Residential properties, which, as already said, provide investors remarkable returns and large monthly cash flow, typically have shorter lease arrangements with tenants than commercial buildings. Commercial property leases are frequently signed for a number of years.
• Company Partnerships: The commercial real estate market presents investors with a rare chance to engage in business partnerships. Compared to residential real estate, this can result in more professional, neighborly interactions with your tenants. You could even be able to develop relationships with the business owners that rent space in your building in some circumstances. Getting connected in the community you are investing in and growing your network are both benefits of doing this.
• Limited Operational Hours: One of the less well-known advantages of managing commercial real estate is that you often work the same hours as your tenants. Commercial property owners normally won’t find themselves responding to after-hours maintenance requests or contacts from other tenants, despite the possibility of modest variations in work hours. On the other hand, residential real estate may need a staff member available round-the-clock to handle problems. This benefit is enjoyed by many commercial investors who choose to handle their own property management since it helps maintain a sense of separation between real estate ownership and everyday living.
Compared to other investment options, commercial real estate investing provides investors with a wide range of benefits and prospects. The next stage is to jump in as soon as the advantages of commercial real estate investing are understood. For advice on how to start a career in commercial real estate, consider speaking with a financial advisor or simply continue here.
Getting Started with Investing in Commercial Real Estate
Due diligence is the only method for investing in commercial real estate that works. No matter what industry or area you operate in, being diligent and doing your research are essential to your success in real estate. Make sure you understand the commercial real estate market and how it can be different from the residential real estate market in addition to studying the ins and outs of business investing. If you’re prepared to start your own business, remember to follow these guidelines:
1. Recognizing the difference in commercial real estate
Understanding that commercial real estate is priced differently from residential properties is the first step for a commercial investor. In contrast to residential real estate, commercial real estate often earns money based on the amount of usable space. Additionally, commercial real estate leases frequently have longer terms than residential leases. These two aspects serve as an example of why a commercial real estate investor has a better chance of generating more money.
“Start by doing your homework,” recommends Matt Woodley of Mover Focus. Make sure you are aware of the benefits and hazards of investing in commercial real estate. Additionally, be ready to make a sizable initial investment and to endure some challenging market conditions.
Regardless of your area of business, including commercial investing, location is a crucial consideration. Commercial investors must, however, also pay particular attention to the kind of their tenants. When determining demand, two elements come into close contact: the location and the planned tenant type. A corporate office building, for instance, will probably function better in an urban area than in a neighborhood that is predominantly residential. You can get a better idea of how your target home might perform by looking at recent comparables.
2. Comparables Analysis
Analysis of local comparisons and future development study come next. These assets, also referred to as “comps,” are the prices paid for recently closed real estate transactions that are comparable in terms of location, size, and style. You can estimate a property’s current market worth by examining comparable properties. A typical guideline when selecting comparable properties is to pick a home whose square footage is no more than 10% more or lower than the home being examined. The most precise comparisons are then made feasible. Learn more about how to get the most precise comparable sales.
3. Using The Correct Success Metrics
A thorough understanding of real estate financing is required for investing in commercial real estate. You need to be familiar with a number of formulas to compete in the commercial real estate market.
• Net Operating Income is the sum of all the revenues and expenses from a specific property. This statistic, which is calculated before taxes, provides investors with an estimate of how much they will receive from an investment after deducting all essential operational costs. Insurance, property management fees, utilities, repairs, janitorial charges, and property tax make up the majority of operating expenses.
• The “cap rate” (also known as the capitalization rate), which is used to determine the value of properties that generate income, gives investors an idea of potential future earnings or cash flow. Essentially, this is the proportion of net operating income to the value of the property assets.
• The Cash on Cash measure gives investors a rate of return on their commercial real estate investments. Investors that use financing to buy their properties frequently employ it. Cash on cash is a metric used to compare the return on investment made with personal funds to the share that was financed. This will give a precise study of the performance of an investment.
The aforementioned formulas are a preface to our comprehensive reference to real estate calculators that every investor should be familiar with.
4. Contingencies on Reserve Costs
In essence, cost contingencies are rainy day funds set aside to pay for unforeseen purchase costs. You can use this part of your spending plan to make up for lost cash flow brought on by early vacancies, renovations, and other upfront expenses. For instance, you could need to employ a new property manager or rezone the property. These expenses might sometimes be incurred prior to having a steady cash flow.
You may make sure you have the money to cover these costs by early budgeting for cost contingencies. In commercial investing, a typical cost contingency budget ranges from 5 to 15%. Examine the anticipated cash flow during the first few months to establish the appropriate investment amount. Will that amount pay for early loan costs? What about alterations to the building? Even if you anticipate early on that your cash flow will be stable, it is always a good idea to have extra money on hand just in case.
Many investors will also set aside a capital reserves fund, which effectively performs the same function later on, in addition to cost contingencies. These funds, which are included in the operational budget, may be utilized for unforeseen costs. Overall, you can prevent financial emergencies by budgeting for these expenses throughout the investment process. Cost contingencies and cash reserves are an essential part of the commercial investing process.
5. Mistakes To Avoid When Investing In Commercial Real Estate
Knowing what to avoid doing as a commercial real estate investor is just as crucial as knowing what to do. The single most important thing a real estate entrepreneur can do for the success of their firm is risk mitigation, something that the best investors of today already know and it’s about time you did too. The best strategy to raise the chance of success is to reduce risk exposure. In light of the foregoing, the following is a list of some of the most typical errors commercial real estate investors should avoid:
• Inaccurate valuations: Since each business property is different, investors must be able to take these differences into consideration. Financial devastation could result from failing to take into consideration every aspect of an asset’s valuation. Investors in commercial real estate must therefore be completely informed of what they are purchasing and at what price. It’s critical to get things right at the moment of acquisition because failing to account for a property’s true value will affect almost every decision going forward.
• Financial Ignorance: It can be disastrous to invest in commercial real estate without understanding the financial complexities involved. Commercial deals are different from residential ones, if nothing else. The loan-to-value (LTV) or debt service coverage ratio are only a couple of the distinctions that investors will need to be aware of (DSCR).
• Neglecting Due Diligence: While the current market demands quick decisions, due diligence should not be overlooked. Instead of agreeing to a contract you aren’t ready for, it is best to let someone else win the deal. As a result, more investors must invest the necessary time to find out as much as they can about a property before making a purchase.
• Working Alone: An excessive number of investors choose to save money by working alone. Working with a team, however, is indisputably superior to working alone. While working alone may initially seem to save you money, the likelihood is that you are actually losing money and time. Having stated that, partner your services with a skilled group and have faith in them to do the task you assigned to them. They probably know more about every step of the procedure than you do.
How to secure various commercial investment loan kinds will be covered in the next section. Knowing the aforementioned figures and methods inside and out is essential when making your case to commercial lenders.
Commercial Real Estate Loan Types
After learning more about commercial real estate investing, including its advantages and suggestions for getting started, you should start considering a crucial factor: how you will finance these assets.
There are many different kinds of commercial investment loans, and it is up to the investor to choose the one that best suits their requirements. There are specific eligibility conditions for each form of loan, such as a minimum credit score, level of experience, and down payment amount. Additionally, the terms of these loans can differ in terms of loan length, interest rate, and loan-to-value (LTV) ratio. For instance, one investor would prioritize finding a loan with lower interest rates over a longer loan period, while another investor might prioritize finding a loan with a shorter duration in order to close a financial deficit. Visit our thorough overview of the various commercial real estate loan types at the link below:
- Small Business Administration (SBA) 7(a) Loan
- Certified Development Company (CDC) / SBA 504 Loan
- Conventional Loan
- Commercial Bridge Loan
- Hard Money Loan
- Conduit Loan
How To Obtain A Loan For Commercial Real Estate
At first, getting finance for commercial real estate could seem frightening. Nevertheless, investors will discover that they are entirely reachable if they understand about the procedure and the many kinds of commercial real estate loans. The primary processes in securing a loan for commercial investment property are listed below:
• Determining whether to finance a commercial property as a person or as a business is the first step. Even while businesses, developers, and business partnerships typically buy commercial real estate, an individual investor can readily buy it as well. Lenders typically require borrowers to submit financial track records in order to acquire a loan because they want to be sure the borrower can return the loan. For newer enterprises with no credit history, the lender will normally demand that the investor(s) guarantee the loan.
• Mortgage Options: It’s critical for investors to understand the differences between residential and commercial mortgages. The first difference is that, unlike residential mortgages, business loans are not insured by government entities like Freddie Mac and Fannie Mae. Second, business loans have different terms than mortgages for houses. Residential loans normally vary from 15 to 30 years, but commercial loans range from 5 to 20 years. Typically, lenders base their selections on an investor’s credit and financial history.
• The loan-to-value ratio of a property is a crucial factor that lenders take into account when financing commercial real estate (LTV). This ratio compares the loan’s value to the property’s worth. It is determined by dividing the loan amount by the appraised value or purchase price of the property. For commercial loans, the LTV will be between 65 and 80 percent, with lower LTVs qualifying for more favourable financing rates.
• Debt Service Coverage Ratio: Lenders take this factor into consideration (DSCR). This indicator gauges a property’s capacity to pay off debt. It contrasts the annual net operational revenue of a property with the annual principal and interest payments on the mortgage. A DSCR of less than 1% indicates a poor cash flow. To maintain proper cash flow, commercial lenders typically aim for DSCRs of at least 1.25.
You are prepared to begin looking through listings as soon as your financing is in place. However, processing all of this data at once is difficult. For answers to some of your most pressing queries, continue reading.
Commercial Real Estate for Beginners
A successful investor in commercial real estate has the potential for a very rewarding career. Multifamily homes are a popular entry point for novice investors into commercial real estate. Regardless, you must have a solid business plan in place before you begin. Every novice investor should be familiar with the answers to the following frequently asked questions about commercial real estate:
• What is commercial real estate?
• How do you make money from commercial real estate?
• Why invest in commercial real estate?
What is commercial real estate? Any property of 5 units or more. We covered this previously but you should be able to immediately answer that it’s Retail Space, Offices, Industrial Buildings, Apartment Complexes and Warehouses. You should know that it’s a more advanced investment strategy than residential real estate which is property of 4 units or less.
How do you make money from commercial real estate? You should know that income is made by collecting rent fro your property occupants each month.
Why invest in commercial real estate? There’s less competition because commercial real estate is more niche than residential real estate. You will find fewer investors in the commercial arena which means there is more opportunity to hone in and acquire properties that best fit your needs. Economies of scale means that the process is the same no matter if you are investing in 5 units or 20 units. You’ll also bring in larger monthly cash flow that is more dependable in the long term. Due to the larger physical size of commercial property, cash flows will be greater than what you would receive from a single family property. The duration of commercial real estate leases are often much longer than those of residential properties. Commercial deals also allow you to pull from more than one lender. You may have a small amount of your own money in the deal while private lenders, banks and other loans can put up the rest. Commercial real estate investments also include fees that you can make payable to yourself. If you raise the money for the property yourself you may be entitled to an acquisition fee when you close on the investment. The acquisition fee is typically 3% of the purchase price.
What Are The Signs That I’m Prepared For A Career In Commercial Real Estate Investing?
Do you have an interest in investing in commercial real estate but are still a little afraid to make the plunge? These three inquiries were created to aid you in determining whether or not commercial real estate is right for you:
Can you think big?
People who want to invest in commercial real estate need to have an expansive mindset. Residential real estate investments typically include substantially smaller-scale properties. Even in the early stages of renovation, you must picture the ultimate product for a commercial property. If you are considering buying a five-unit apartment vs a property with ten or more units, the ten would generally be a better investment. It makes sense to think large and take whatever steps are necessary to increase your bottom line if the commercial finance needed for the five-unit building is almost the same as for the ten.
Are you great at building relationships?
While networking and establishing connections are crucial for residential real estate investors, they also crucial for commercial investors. Building connections with other commercial investors and private lenders is primarily done for financial reasons. You’ll probably need funding if the buying price is $1,000,000 or higher. What better strategy to obtain financing than to get in touch with one of your existing personal private lenders? Once you’ve established a network, you may rely on other people who have made mistakes and know how to avoid repeating them.
Can you do your due diligence and execute successfully?
Perform your due diligence before getting started with commercial real estate investing. This is arguably the most crucial thing new investors can do. You must do as much study as you can on your selected niche after making your choice. Ask inquiries to like-minded people at your local REI club, research various forms of financing online, and make prior contact with private lenders. So when the time comes, you will have just what information to give them. You will be prepared to enter into your first commercial real estate deal effectively once you have completed rigorous due diligence.
What about your Real Estate license?
Although it can lead to professional opportunities, obtaining a real estate license is not necessary to start investing in commercial real estate. Obtaining your real estate license and handling deals part-time might help you network professionally within the sector while also generating income through commission. Many investors might use these money to buy commercial real estate and expand their portfolios right now.
In spite of this, obtaining a real estate license involves completing training sessions, passing exams, and other requirements. Even just getting started as an agent will need time, which can be challenging if you are also beginning to build your investing portfolio. Some investors decide against getting their own license in favor of establishing a network with real estate brokers.
Although investing in commercial property may initially seem overwhelming, you should know that the fundamental skills and abilities needed are the same as those needed for residential property investing. They include exercising due diligence, creating a strong network, and creating a proper business strategy that considers financing choices. Any sort of investing carries some level of risk, so it’s up to you to figure out how to reduce it. You will undoubtedly achieve success if you use the strategies that helped you succeed in residential real estate to your commercial plan.
Source Disclosure: This article was paraphrased from an article on Fortune Builders and repurposed for educational use. It is designed to encourage people to seek professional financial advice through our short Finance Quiz. Click below to access the original article.