Real estate investment is a great way to diversify your portfolio and increase your wealth.
However, many individuals often concentrate on residential properties when they enter into real estate investment. While these residential properties can be lucrative, commercial real estate offer higher financial gains.
Fortunately, even novice investors can acquire the necessary knowledge and tools to venture into commercial real estate investment. In this beginner’s guide, we are going to discuss the basics of commercial real estate investment.
What is Commercial Real Estate?
Commercial real estate refers to properties primarily leased out for business and retail purposes. Investing in commercial real estate involves acquiring or constructing properties specifically designed to accommodate commercial tenants.
Unlike residential real estate investors, commercial real estate investors derive rental income from businesses occupying their properties rather than residential tenants. It’s important to note that the definition also encompasses raw land purchased for commercial property development.
Various property types fall under the category of commercial real estate, such as:
• Office spaces
• Warehouses and other industrial structures
• Retail spaces, storefronts, and shopping centers
• Medical buildings, healthcare facilities, and hospitals
• Storage facilities
• Apartment buildings with five or more units
• Hotels and resorts
Important Terms to Understand When Investing in Commercial Real Estate
Before you consider investing in commercial property investment, you need to understand these terms:
A lease is a legal agreement between a property owner and a business tenant. A lease outlines the terms and conditions for property use, including rent increases and maintenance.
• Capitalization Rate (Cap Rate)
It indicates the potential return on investment in a commercial property. Cap Rate is calculated by dividing net operating income (NOI) by the property’s price or value.
• Gross Rent Multiplier (GRM)
It compares a commercial property’s value to its rental income. GRM is calculated by dividing the property price by the annual gross rental income.
• Net Operating Income (NOI)
It measures a commercial property’s income after deducting operating expenses. NOI helps to assess profitability and determine the cap rate and property value.
• Triple Net Lease (NNN Lease)
It is a commercial lease where the tenant covers all operating expenses, such as taxes, insurance, and maintenance, shifting the responsibility from the property owner to the tenant.
• Tenant Improvements (TI)
These are modifications made by a tenant to customize a commercial property for their business needs, either paid by the tenant or property owner.
Why Invest In Commercial Real Estate?
Here are some benefits of investing in commercial real estate properties:
• High-Income Potential
Investing in commercial real estate offers higher potential income compared to residential properties. Commercial properties have lower vacancy risk, more units, and longer leases, which helps you to earn higher returns.
• Longer Leases
One significant benefit of commercial real estate is longer lease agreements compared to residential properties. These extended contracts provide investors with impressive returns, significant monthly cash flow, and increased stability, often spanning multiple years.
• Consistent Income
Commercial real estate offers a consistent cash flow due to longer lease periods. With more units and economies of scale, investors can multiply income streams. Triple net leases can further enhance owner benefits as tenants cover taxes, insurance, and maintenance costs.
• Professional Relationships
Commercial real estate offers investors the chance to foster business-to-business relationships, leading to professional interactions with tenants. Building relationships with business owners renting in your property can expand your network and involvement in the community.
• Limited Hours of Operation
Operating commercial real estate comes with the advantage of limited operational hours. Commercial property owners typically share working hours with tenants, reducing the need for around-the-clock maintenance and communication.
• Lower Competition
Commercial real estate presents an advantage of lower competition due to its perceived complexity, resulting in a less saturated market with fewer investors vying for opportunities.
• Inflation Hedge
Commercial properties serve as an inflation hedge due to their resilience. As property prices rise during inflation, owners can increase rent and witness property value appreciation, offering potential financial benefits.
Types of Commercial Real Estate Investing
Here are the different types of commercial real estate investing options:
• Direct Ownership
Purchase a commercial property outright, gaining complete control over property management and generating income through rent and appreciation. Requires 20%-30% of the property’s purchase price to start.
Join forces with other investors to purchase and manage commercial properties, spreading risks and costs. Capital requirements vary based on property cost and number of partners.
• NNN Investment Properties
Through NNN investment properties, an investor purchases commercial property and leases it back to a single tenant. They can be a great way to make a substantial profit while maintaining a low level of risk, provided that you go with one of the best NNN investment options.
• Commercial Mortgage-Backed Securities (CMBS)
Indirectly invest in commercial real estate by purchasing securities backed by commercial mortgages. Generates passive income but excludes property appreciation participation. Capital requirements vary.
• Private Equity Deals or Funds
Pool money with other investors to acquire and manage commercial properties. Offers exposure to institutional-grade assets but can be illiquid and subject to fees. High capital requirements, often starting at $25,000 or $50,000.
Types of Commercial Real Estate Loans
If you want to acquire funds for commercial property investment, here are some options:
• Certified development company (CDC) / SBA 504 loan
• Small business administration (SBA) 7(a) loan
• Commercial bridge loan
• Conventional loan
• Hard money loan
• Conduit loan
These loan options have varying eligibility requirements, terms, and benefits, allowing investors to choose the financing option that aligns best with their needs and investment goals.
Key Commercial Real Estate Professionals to Include in Your Network:
Networking is extremely important when it comes to commercial real estate investment. Here are some key professionals you need to include in your network:
• Lenders or mortgage brokers
• Commercial real estate agent
• Property management company
• Insurance agent
• Contractor or handyman
How to Start With Commercial Real Estate Investment?
Follow these steps if you want to invest in commercial properties:
• Step 1: Define your investment goals and strategy
• Step 2: Educate yourself about commercial real estate
• Step 3: Assemble a professional team
• Step 4: Create a seller credibility packet
• Step 5: Analyze and identify investment opportunities
• Step 6: Mind your due diligence
• Step 7: Secure financing and make an offer
• Step 8: Create a long-term plan
Mistakes to Avoid When Investing in Commercial Properties
Avoid these common mistakes when you invest in commercial real estate:
• Improper valuations of the property
• Neglecting due diligence
• Not understanding the financial complexities
• Not working with a team
Investing in commercial real estate is a lucrative opportunity for novice investors. You can enjoy a higher and long-term income through rent and capital appreciation with commercial properties.
We hope that our guide has helped you grasp a basic understanding of investing in commercial real estate. Here, you can get access to valuable resources and expert guidance about different types of investments.
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