Commercial real estate investing can be a great way to grow your portfolio and see consistent returns. However, there are a few things you need to know before getting started.
This article will cover the 10 most important things you need to know about commercial real estate investing. By knowing these key points, you’ll be able to make more informed decisions and increase your chances of success.
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1. Property
There are four main types of commercial real estate assets: office, industrial, retail, and multifamily:
Office
Office properties are used by businesses and organizations to house their operations. They can be single-tenant or multi-tenant buildings, and are typically leased on a long-term basis. Within the office asset class there are several sub-classes or categories, including medical and life science office buildings, and suburban office parks.
Retail
Retail properties are used for businesses that sell goods or services directly to consumers. They can be freestanding stores or located in shopping centers or malls. Some examples of retail sub-classes include neighborhood strip malls and grocery-anchored shopping centers.
Multifamily
Multifamily properties are residential buildings that contain multiple units, such as apartments or condominiums. They are typically leased on a short-term basis. Buildings with more than four units are considered commercial real estate, not residential. High-rise apartment buildings and garden-style apartment complexes are two examples of multifamily sub-classes.
Industrial
Industrial properties are used for manufacturing, distribution, and storage purposes. They often have features such as loading docks and high ceilings. Industrial space generally falls into one of three sub-classes: warehouse/distribution, manufacturing, and office service/flex space.
Assets that don’t neatly fit into the above four asset classes are often categorized as “Special Use” properties. Commercial real estate assets that are special use may include student housing, assisted living facilities, mixed-use properties, data centers, and single-tenant triple-net leased buildings.
Each of these asset classes has its unique characteristics and risks. For example, office properties tend to be more stable and generate steadier income than retail properties, which can be more volatile. Industrial properties may be less expensive to purchase but require more specialized knowledge to operate successfully.
The type of commercial real estate asset that is right for you will depend on your investment goals and objectives. For some investors, the stability of office properties makes them a good choice, while others may prefer the higher potential returns of retail assets. Whatever your goals, it’s important to research and understand the different types of commercial real estate before investing.
2. Location
There are a few key factors to consider when choosing the right location for commercial real estate:
- Population density: The more people in an area, the more potential customers or tenants you will have. Look for areas with high population growth rates to maximize your potential return on investment.
- Proximity to transportation: Good access to public transportation and major highways can make your property more attractive to tenants or buyers. This is especially important if your property is in a suburban or rural area.
- Zoning regulations: Before you purchase any property, be sure to research the local zoning regulations. Some areas have strict limits on what types of businesses can operate there, which could impact your ability to sell or lease the property in the future.
- Crime rates: No one wants to live or work in an area with a high crime rate. Check the local crime statistics before making any decisions about investing in a particular location.
- Economic conditions: The overall health of the local economy should also be taken into account when choosing a location for commercial real estate. Look for areas that are experiencing economic growth and have low unemployment rates.
3. Returns
In commercial real estate investing, there are a variety of different financial calculations that can be used in order to determine returns.
Gross rent multiplier (GRM)
Often used to quickly estimate the potential return on investment for a property. To calculate the GRM, you take the property’s purchase price and divide it by the annual gross rent that the property generates.
Capitalization rate (cap rate)
A measure of the net operating income (NOI) generated by a property divided by the purchase price. The cap rate can be a useful tool for comparing properties with different NOI levels, as well as estimating the potential return on investment.
Cash on cash return (CoC)
Another metric that takes into account the financing used to purchase a property. To calculate the CoC, you take the pre-tax net cash flow of the property, then divide that by the total amount of cash invested in the property (including the down payment and any closing costs). The CoC can be a useful metric for assessing the riskiness of an investment, as well as the potential return.
Internal rate of return (IRR)
Measures the profitability of an investment, taking into account both the initial investment and any ongoing cash flows. To calculate the IRR, you use a financial calculator or spreadsheet to find the interest rate that makes the present value of all future cash flows equal to the initial investment.
These are just a few of the different financial calculations that can be used when assessing commercial real estate investments. Each has its own advantages and disadvantages, so it’s important to select the method that makes the most sense for your particular situation.
4. Taxes
Commercial real estate property taxes are typically based on the value of the property, and they are generally much higher than residential property taxes. The reason for this is that commercial properties tend to be more expensive than residential properties. In addition, commercial properties generate more income than residential properties, so the government views them as a bigger source of revenue.
When calculating commercial real estate property taxes, the government takes into account the size of the property, its location, its assessed value, and its taxable value. The taxable value is the portion of the property’s value that is subject to taxation. The assessed value is the portion of the property’s value that is used to calculate the tax rate.
The size of the commercial real estate property tax bill depends on the tax rate, which is set by the government. The tax rate for commercial properties is generally much higher than the tax rate for residential properties. The reason for this is that commercial properties generate more income than residential properties, so the government views them as a bigger source of revenue.
To find out the property tax rate for a particular piece of commercial real estate, you can start by contacting the local municipality or county assessor’s office. They should be able to provide you with this information.
Another resource you can use is commercial real estate listing websites. Often, these will include the property tax rate as well as other important details about the property.
5. Insurance
As a commercial real estate investor, you need to make sure you are adequately protected against any potential risks that could come your way. That’s why commercial real estate insurance is so important. But what types of insurance should you get? And how much coverage do you need?
The insurance you need depends on the type of commercial real estate property you own. For example, if you own an office building, you may need a different type of insurance than if you own a retail space with a lot of traffic from the general public. And the amount of coverage you need will also vary depending on factors like the value of your property, the property asset class, age and condition of the property, and the location.
Here’s a breakdown of the different types of commercial real estate insurance you should consider:
- Property insurance: This covers the physical structure of your commercial real estate property, as well as any landlord-owned contents that are inside.
- Liability insurance: This protects you in the event that someone is injured on your property or if you are sued for damages.
- Business interruption insurance: This reimburses you for lost income if your property has to shut down temporarily due to a covered event, such as a fire or natural disaster.
6. Financing
There are a few key differences between financing commercial real estate compared to residential real estate. For one, the down payment amount is usually larger for commercial properties – often around 20-30% of the total purchase price. The loan term is also usually shorter, typically around 5-7 years, and the interest rate is usually higher.
There are several different options for financing commercial real estate, including traditional bank loans, SBA loans, private equity loans, and bridge loans:
- Traditional bank loans are the most common type of financing for commercial real estate and usually have the lowest interest rates.
- SBA loans are backed by the Small Business Administration and typically have lower interest rates and longer terms than traditional bank loans.
- Private equity loans are usually provided by investment firms or wealthy individuals and tend to have higher interest rates and shorter terms than other types of financing.
- Bridge loans are short-term loans that are typically used to finance the purchase of a property before longer-term financing is secured.
Each option has its own set of pros and cons, so it’s important to do your research and choose the best option for your needs.
7. Management
As an investor in commercial real estate, you may wish to consider hiring a property management company to take on some of the tasks associated with owning and operating your property. While there are some upfront and ongoing costs associated with hiring a property management company, there are also many potential benefits.
Here are eight main duties and responsibilities of managing commercial real estate that a property management company can help with:
1. Maintaining the property: This includes tasks like keeping the grounds clean and running any necessary repairs or maintenance.
2. Rent collection: A property management company can handle collecting rent from tenants, following up on late payments, and enforcing any late fees or other penalties.
3. Financial reporting: A good property management company will keep track of all the finances associated with your commercial real estate property, including income and expenses. They can provide you with regular reports so that you can see how your property is performing financially.
4. Tenant screening: A property management company can help you screen potential tenants to make sure they are a good fit for your property. This includes running background checks and credit checks.
5. Lease enforcement: Once tenants move in, a property management company can help enforce the terms of the lease agreement. This includes making sure tenants are following any rules and regulations that are in place.
6. Evictions: If necessary, a property management company can handle the eviction process for tenants who violate their lease agreement or fail to pay rent.
7. Contract negotiation: If you need to renegotiate your mortgage or other contracts associated with your commercial real estate property, a property management company can help with that process.
8. Regulatory compliance: There are many regulations that commercial real estate properties must comply with, such as fire codes and building codes. A property management company can help make sure your property is in compliance with all applicable regulations.
8. Maintenance
There’s more to commercial real estate maintenance than just mowing the lawn and shoveling the sidewalk. As a commercial property owner or manager, you’re responsible for ensuring that your property is well-maintained and safe for both tenants and the general public. That means keeping up with routine tasks like inspecting the premises, checking for hazards, and performing preventive maintenance, as well as handling one-time repairs and improvements.
Why is all this important? For one thing, it’s key to protecting the health and safety of everyone who steps foot on your property. But maintaining your property is also crucial for keeping occupancy levels high and tenant turnover low. After all, who wants to live in or do business in a run-down building? Finally, regular commercial real estate maintenance can help increase your property’s value over time.
By taking care of your commercial real estate, you can help to ensure that it remains a safe and desirable place to work, shop, and live.
9. Leasing
When leasing commercial real estate space, landlords should follow a few key steps to ensure a smooth and successful process.
First, you’ll need to determine what type of tenant you’re looking for. Are you hoping to attract a retail business? An office space user? A restaurant? Once you know what type of tenant you’re looking for, you can start advertising your available space.
Next, it’s time to screen potential tenants. This is an important step, as it will help you find a good fit for your property. When screening commercial tenants, you’ll want to look at their credit history, financial stability, and business plan. It’s also important to make sure that the tenant’s use of the space will be compatible with the other businesses in your commercial real estate property.
Once you’ve found a tenant that you’re happy with, it’s time to negotiate the lease. This is where you’ll determine things like the length of the lease, the amount of rent, and any special provisions that need to be included in the agreement.
Commercial real estate leases are different from residential leases in a few key ways. For one thing, they tend to be much longer – often 5 years or more. Additionally, commercial leases often include provisions for things like common area maintenance (CAM) charges and percentage rent. Finally, commercial leases typically have a much higher security deposit than residential leases.
10. Sale
When the time comes to sell commercial real estate, the first step is to put together a marketing sales package. This should include information on the property, such as square footage, number of parking spaces, and any special features or amenities. You’ll also want to provide information on the local market, including recent sales data and rental rates.
Once you have a complete marketing sales package, you can begin reaching out to potential buyers. It’s important to remember that commercial real estate transactions usually take longer than residential deals, so don’t be discouraged if it takes a while to find a buyer. Once you’ve found a prospective buyer who’s interested in your property, you’ll need to negotiate a letter of intent (LOI). This document outlines the terms of the sale, such as the purchase price, closing date, and any contingencies.
After both parties have agreed to the general terms and conditions outlined in the the LOI, you can draw up and sign a legally-binding purchase and sale contract and begin the due diligence process. This typically includes an inspection of the property and a review of any environmental reports. The due diligence period is usually 45-60 days, but it can be extended if necessary. After all inspections and reports have been completed, it’s time to finalize the sale and transfer ownership of the property.
Closing Thoughts
Commercial real estate can be a great investment, but there are a few things you need to know before you get started. First, it’s important to understand the difference between commercial and residential real estate. Commercial properties are usually larger and more expensive than residential properties, and they come with different risks and rewards.
Next, it’s important to have a clear idea of what you hope to achieve by investing in commercial real estate. Are you looking for income? Appreciation? Or both? Once you know your goals, you can start researching the different types of commercial real estate investments and determine which one is right for you.
Finally, remember that commercial real estate transactions take longer than residential deals, so be prepared for a bit of a process. But if you do your research and find a good property, the rewards can be well worth the effort.
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Blog post written by J. Scott Digital freelance copywriting services, featured photo by Naman Pandey on Unsplash.
