Commercial real estate can be an appealing proposition for most investors. It delivers you the chance to dive into a new client pool and significantly grow your business interests. But the commercial real estate is also a different beast that will need additional considerations compared to residential real estate investing.
Commercial real estate is a good investment due to its passive income, consistent returns, and growth potential. Commercial investing is gaining popularity tremendously as an alternative investment. While it has the potential to be highly profitable, not all commercial investments can be considered equal. Having a clear understanding of what, when, and how to invest in commercials is an essential step of success or failure.
Besides, it is crucial to know its pitfalls, mistakes, and risks, too, so that you can prepare yourself before diving into real estate. If you intend to invest in commercial real estate, here are things you should know before you get started.
It Can Take Longer Than You Think, So Be Patient.
Everything here takes longer than residential investment. Instead of days, due diligence is months. It takes longer to find new tenants. Constructing or refurbishing takes much time. But the leases are also longer. Patience is crucial.
Know The Market
As an investor, you need to understand the market you are investing in. having better wherewithal of the crucial fundamentals such as legal implications, vacancy, rents, competition, etc., will allow you to make smart investments that could significantly yield high returns. This will allow you to fine tube your commercial real estate investment and diversify your portfolio.
Prepare Yourself to Have an Active Role.
Commercial real estate investment is not a passive investment. Most professional entrepreneurs have an active role to play. They have systems and processes put in place to ensure that the property has its full operational potential. They constantly keep tabs on local market development and economic trends and broader economic trends.
Study The Demographics
The study of local property demographics gives valuable insights into your potential investment. Request a demographic report which tells you about population, median household, personal income, and more. Understanding the population allows you to understand who will visit your next investment property.
For example, in an area with a younger population, such as millennials, student debt, and small savings are likely to be huge or disposable. This demographic may have more disposable income in comparison to an area predominantly within the baby boomer age range. Neighborhood amenities also play a significant role in demographics.
Consider The Commercial Real Estate Investment Debt Instead.
Most investors are not aware that there is an excellent opportunity to invest in real estate with fewer risks and higher potential return more than the property ownership – through CRE debt. Having returns in the range of 8-10 and a more robust standing than facility owners in a market correction event, this chance is mainly overlooked by people looking to dive into CRE investing.
Location Is an Essential Factor.
No matter how good a property appears, nothing is more important for most investors than where that property is located. Whether these regions are top-tier or emerging markets, locations that boast strong job, demographic and economic growth factors are a good starting point.
Investors should consider whether the asset is in the desired neighbourhood and even on a specific block in a strong market. Some markets and submarkets’ strength can vary from one street to another, so it’s a must.
A CRE asset’s location is a significant factor that can attract and retain tenants who are the vital building blocks of any commercial property investment. A good location paves the way to a successful investment.
A property near high-ranking schools, monuments, and popular attractions is more desirable and generally of higher value. This information is helpful for future tenants when setting up and marketing the property.
Not All Commercial Properties Are the Same.
Commercial property has a wide range of assets. Although CRE is naturally divided into five major areas, industrial, multi-family, office, retail, and particular purposes, many other property types include self-care, medical, elderly, land, or hotels. Offer and demand, yield, and overall profitability vary considerably in each sector.
Some property types do better than others based on the supply and demand at the asset’s particular location. But some sectors perform better than others, even at a macro level. It is essential to know how to identify the most profitable or major asset types in the current economy.
Understand The Commercial Investment Market Cycles
Nothing can last forever. The unemployment rate, economic health, and GDP will be correlated to commercial real estate profitability. Knowing how the CRE market cycles function can help you avoid purchasing when the market is high and then forced to sell your property when the market is very low.
Besides, knowing specific indicators on different market circles will absolutely help you to determine what opportunities are present right now and make informed decisions regarding commercial real estate investment.
Assess Risk by Property Type
The risk is different in commercial real estate when compared to a residential one. While the success of two residential properties right next to each other is typically similar, two commercial properties’ success in one position could fluctuate independently. Therefore, it is crucial to understand the range of risks inherent to the investment.
Be Sure to Have a Capital Reserve and Contingency Fund
Any investment is always uncertain. No matter how much you have researched, verified, or prepared, unknown factors can always positively or negatively affect your overall yield. One way of preventing this uncertainty is to take into account costs.
Most contingencies are additional funds that will be allocated to help with unforeseen expenses when you lease, increase rents, exchange-manage, renovate, rezone or build, as part of your initial acquisition cost. They can also help cover your debt until the property is stabilized. Cost contingencies are particularly useful if the cash flow is negative while improving the property’s overall performance. In commercial investing, the standard contingency budget is 5% -15%, but it will vary depending on the asset and whether it is inefficient or not.
A capital reserve is an account or fund with long-term improvements or unexpected expenditure beyond your initial improvements in capital. This is money you spend before netting any positive cash flow, usually 3% – 5% of gross rents. Budgeting these two factors during your investment analysis will increase the chances of profitability and provide the funds for unforeseen events.
While diving into the CRE investment space seems to be a challenging task, approaching it systematically can be beneficial. Keeping in mind commercial investment’s cyclical nature, the impact of capitalization, property location, etc., while evaluating these investments can guide you towards making a reliable decision that brings you close to your financial goals.
