How To Invest In Commercial Real Estate
Are you looking and are interested in investing within commercial real estate? On-point partners can help you find the best most reliable ways to invest. Take a look at how you can properly learn how to invest in commercial real estate.
Commercial real estate (CRE) is an appealing investment class because of its consistent returns, passive income, and growth potential. This sector of real estate investing is becoming more and more popular as an alternative investment. However, while CRE has the potential to be profitable, not all commercial investments are considered equal. Knowing when, what, and how to invest in commercial real estate is an essential component of success or failure.
What Is Commercial Real Estate?
Commercial Real Estate (CRE) is defined as any property used primarily for business purposes. Simply put: pretty much anywhere you wouldn’t rest your head at night as the owner. There is a slight exception, though, with multifamily and hospitality real estate, but those are still a commercial use. Commercial real estate may be owner-occupied, meaning the owner of the property operates their business at that location, or maybe leased to tenants who wish to live/work there.
Real Estate Crowdfunding Platforms
Thanks to online real estate crowdfunding platforms, you can buy a property with less know-how, less work, and less risk. Minimum required investments can be as low as $1,000. With these sites, you can purchase a “share” of a real estate mortgage or loan. But in order to take advantage of many of these opportunities, you must be an accredited investor.
Crowdfunding is not new, but the 2012 Jumpstart Our Business Startups (JOBS) Act kicked this industry into high gear here in the U.S. many platforms offer commercial deals to choose from.
Real Estate Investment Trusts
Real estate investment trusts (REITs) are a good solution for small investors who don’t want the hassle of finding, buying, and managing properties themselves. Or doing all the due diligence of investing in a specific property on a crowdfunding site. And that’s not the only advantage they have. By law, REITs are required to pay out 90% of their earnings in the form of dividends. And you are not required to be an accredited investor.
REITs are an easy way to add real estate to diversify a portfolio. And they can provide passive income. The downside is that there’s less upside when investing in REITs because someone else is doing the work for you. And you need to watch out for high fees. REITs can have upfront sales “loads” (fees) that are much higher than with mutual funds and exchange-traded funds (ETFs).
The Benefits Of Investing In Commercial Real Estate?
The hallmark benefit of investing in commercial real estate is higher potential income. Most commercial properties bring in a higher rent per square foot of space. Plus, you have multiple spaces generating rental income all under one roof. So, many of the maintenance and repair costs are “fix once and done” and spread across many leases. Higher rental income and lower maintenance costs lead to a more profitable investment.
Increased Buying Power Through Leverage
The most outstanding benefit of investing in commercial real estate, in my opinion, is your ability to increase your buying power through leverage. Leveraging means utilizing borrowed capital (debt) to make an investment. The investor’s expectation is that the profits from owning and operating the property will be greater than the payable interest.
As long as that statement is true, you can put down a smaller percentage of the purchase price, typically around 20-25%, finance the remainder, and go on to invest in more properties in the same way. As a passive investor in commercial real estate, you pool your money with other investors to buy an even larger, more stabilized asset than any of you could likely afford or care to risk alone. Who wouldn’t want to buy more with less money?
In commercial real estate, an asset’s value is directly correlated to its Net Operating Income (NOI). By raising a property’s net operating income, you can increase the value significantly to any potential investors.
This intrinsic appreciation is largely due to the commercial real estate industry’s use of capitalization rates (cap rates). A cap rate is the net on investment of any given property if you paid all cash. For example, if you paid $100,000 cash for a property and it netted you $10,000 per year, that would give you a 10% cap rate.
Investors use this metric on a cash basis because each investor group’s financing will vary from one to the next. In commercial real estate, you have far greater control of a project’s destiny, whereas investments like stocks and bonds don’t allow you to have much more influence other than buying and selling based on the market.
Commercial real estate provides investors with a number of tax advantages. You will be able to deduct the interest payments you make on your mortgage, meaning not only are you utilizing someone else’s money to purchase a larger property, but you can also write off their cut for providing you with that cash.
Buildings also begin to depreciate the minute that you buy them. The IRS allows commercial properties to be depreciated over a 39-year schedule, but you can speed up this process by taking advantage of accelerated depreciation if you do a cost-segregation study. Essentially, you get a write-off just for owning the property!
Other deductions include any renovations, maintenance, ongoing upgrades, or any other out-of-pocket expenses related to owning the property. After you sell the property, you’ll also benefit from capital gains tax, which is significantly lower than most investors’ ordinary income tax, and you can even 1031 exchange those proceeds into another piece of real estate without paying taxes at all.
Different types of commercial real estate
As the name suggests, office property consists of real estate used for office buildings. This includes skyscrapers and high-rises in urban areas, along with office parks and mid-rises in suburban areas. Example tenants could include a law firm or start-up company. Office space can come in a range of styles and sizes. Lease terms for commercial real estate are often longer, in the five-year to ten-year range.
Industrial real estate is used for industrial business operations. This can include heavy manufacturing, warehouses, assembly, and research and development buildings. Oil refineries (heavy manufacturing), Amazon distribution centers (warehouses), product assembly factories, and pharmaceutical research and development facilities fall into this category. These properties aren’t generally located in areas that would be very desirable for a residential or retail property, and their placement is guided by zoning regulations that apply to their industrial business operations. Lease agreement lengths for industrial real estate are typically for five years or more.
Retail commercial real estate includes properties that provide the spaces required for retail businesses to conduct business with the public in general. Clothing shops and restaurants are considered retail real estate. This kind of commercial real estate can be developed in large multi-tenant complexes in the form of shopping malls, strip malls, factory outlets, or other such shopping centers. It can also take the form of a single-tenanted standalone building. The earning potential of retail real estate for its owner can depend largely on its specific geographic location, because it significantly impacts which retail tenants will want to set up shop there. Retail leases also tend to be mid- to long-term, often in the 4-5 year range.