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Investing in commercial real estate can have huge benefits and be a great investment opportunity. Commercial real estate investments gain income through leasing out the property to businesses and the appreciation of property value over a period of time.
Depending on the property’s location, the economy’s health, and other external factors, this annual return on investment ranges from 6% to 15% of the property purchasing price. Keep reading to learn how you can start investing in commercial real estate.
What Is Commercial Real Estate Investing?
In short, commercial real estate (CRE) investing is the process of purchasing land or property to lease out. Similar to residential real estate investing, instead of the tenants being individuals, commercial real estate investors lease out to businesses or entities.
Because of this, commercial real estate investors tend to acquire longer leases and have to purchase larger properties.
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How Does Commercial Real Estate Investing Work?
Commercial real estate (CRE) investing traditionally has been the purchasing of land and leasing it out to businesses and other entities. However, if you are not ready for that big of a purchase, there are other ways to invest in real estate.
For example, there are commercial real estate REITs, mutual funds, and ETFs. This allows you to be a passive investor in the property.
Types of Commercial Real Estate
This type of investment comes in different shapes and sizes. Here are some examples of commercial real estate spaces.
- Offices: Best for those looking for an investment with a long standing lease
- Industrial (Shipping, Manufacturing, Warehouses): Best for those who want to minimize reinvestment costs
- Retail Spaces or Restaurants: Best for those who want smaller deposits and lower rates
- Apartment Complexes: Best for those who want a highly lucrative investment since this opportunity tends to have low supply & high demand
- Parking Lots: Best for those who are spotting high potential properties and areas
Commercial Real Estate Investing Benefits
Prior to investing in commercial real estate (CRE), one should understand what are the perks of this type of investment.
- High Profit Potential: These investments can bring in thousands of dollars of profit when chosen wisely.
- Tax Advantages: Can deduct the property’s depreciation from your annual taxable income. Additionally, you can avoid capital gains tax when you decide to sell the property.
- Less Turnover: Commercial property leases start at the minimum of 3 years.
- Less Competition: In comparison to residential investment properties, it has significantly less competition.
Disadvantages of Commercial Real Estate Investing
As with all investments, with a certain amount of reward comes a certain amount of risk. Here are some of the risks associated with investing in commercial real estate:
- Upfront Capital: Since banks dictate commercial properties as high risk investments – the loan value ratio is lower (typically only lending around 60 – 70% of the property’s value). Due to this, a large payment of capital is required.
- Economic Downturns: With unexpected events, like COVID-19, commercial properties suffered.
- Complex Lease Agreements: More terms in the agreement can be up for negotiation in comparison to residential leases.
- Vacancies: It can take a while prior to finding the right tenant to agree upon a lease. Meaning the property would be vacant while you would be reliant on the costs.
7 Steps for Commercial Real Estate Investing
Here are the seven steps you need to start off your commercial real estate investment journey.
Step 1: Understand Differences in Commercial vs. Residential Real Estate
Although this might be seen as a small step, it is a valuable one. Understanding what qualifies a property to be residential or commercial will help you lessen your selection.
In addition, it will help you understand the benefits and disadvantages that come with both investment properties.
Step 2: Decide Which CRE Type & Research Profitable Locations
Since there are a large amount of CRE options available, decide which type of properties are most suitable for your investment needs. Once you figure out which type of property is best for you, research what would be a profitable location for this property type.
For example, a parking lot would be most profitable when located near a mall strip. Location can greatly impact your return on investment so it is extremely important to research areas with high potential.
Step 3: Analyze Comparable Properties
Prior to deciding on an investment property, look into its comparables (also known as comps). These are recently sold or leased properties that are similar to yours.
How to choose these comparables is by looking at its income characteristics, physical features, location, and transaction dates. By knowing this information, it can help you determine the value of your property and what you can lease the property for.
Step 4: Be Cognizant of Market Cycles
Before making a decision on your investment, understand the current economic state the market is in. Additionally, this information will inform you on how well your property does in different economic or market cycles. This can help create a realistic standard of how much return you can expect to get out of your property.
Step 5: Financial Preparation
Since commercial real estate requires a large amount of upfront capital. One should make sure that they are in a financial position to make this type of investment.
Additionally, one should look into loans to help lessen the load of upfront payment. Some examples include the SBA loans, permanent loans, bridge loans, or blanket loans. When applying to these loans one should have a great credit history and score.
Step 6: Understanding the Risks & Contingency Planning
Even though commercial real estate investments are a great opportunity to make a large amount of money, they come with risk. It is important to set up a contingency plan in order to lessen as much risk as possible.
Additionally, it is crucial to fully understand all the potential risks involved when making an investment of this size.
Step 7: Using Targeted Success Metrics
Depending on the property type, different targeted success metrics can be put into place. The main success metrics involve: conversion, revenue, custom scoring, and time on site.
These metrics can be defined differently depending on the property type but are a good structure to put into place to dictate whether your investment is reaching your set out goals.
Get Started Investing in Commercial Real Estate With RealtyMogul
Commercial real estate investing can be a highly profitable investment opportunity for those who wish to diversify their portfolio. RealtyMogul is a great option for investors who don’t know where to start.
This highly accredited platform has a large range of REIT products and buyback programs with high rates of return. Learn more about RealtyMogul and how to open an account here.
Frequently Asked Questions
Commercial real estate investing can be a great investment opportunity for those who wish to diversify their portfolio.
In short, yes. However, whenever there is an opportunity to make a large amount of money there is also a possibility of losing a lot of it.
A good ROI ranges around 6 – 12% on commercial properties.
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