Any type of property, whether commercial or residential, can be an excellent investment. Commercial assets often provide more financial benefit for your money than residential properties such as rental flats or single-family homes, but there are also more hazards.
Understanding the full pros and cons of investing in commercial real estate investment is critical in order to make the best investment decision for you.<\/p>
Commercial real estate refers to asset classes that are not single-family residences. They can be multifamily (four or more connected dwellings), retail spaces or offices, industrial or factory properties, or a combination of these. Any type of property, whether commercial or residential, can be a good investment. Commercial properties typically provide more financial reward for your money than residential properties such as rental apartments or single-family homes, but there may also be more risks.<\/p>
Understanding the whole advantages and cons of investing in commercial properties is critical so that you can make the best investment decision for you. or even buildable land<\/p>
Because commercial properties are larger in scale, they allow you to build your portfolio<\/a> faster than buying individual homes. Naturally, any real estate investment has the distinct advantage of allowing you to leverage, or mortgage, your investment.<\/p> We’ll go over the eight different types of commercial real estate below, looking at each of the following:<\/p> We’ll look at several building types, property types, and land use types, as well as some examples of each asset class along the road.<\/p> Multifamily properties serve as a bridge between residential and commercial real estate.<\/p> While they can be used primarily as a residence, the general purpose of the property type is for investment (owner-occupied or not).<\/p> The multifamily asset class includes everything from a duplex to a multi-hundred unit apartment building.<\/p> Duplexes are two-unit rental properties, triplexes are three-unit buildings, and quadruplexes are four-unit properties. It’s quite straightforward.<\/p> The \u201cplex\u201d suffixed property types are found in almost every market, although they are more suitable for first-time investors and those looking to profit from their own home (by renting out other units).<\/p> Apartment buildings, on the other hand, are often classified as low, mid, or high rise based on the number of stories they have.<\/p> Suburban garden flats first appeared in the 1960s and 1970s, as young people moved from cities to the suburbs.<\/p> Garden apartments are typically 3-4 floors tall, with 50-400 units, no elevators, and surface parking. It is essentially a cluster of low-rise apartment buildings on one piece of land, some of which may share a yard or other land area.<\/p> These complexes are typically 5-12 floors tall, with 30-110 units with elevator service. These are frequently built-in urban infill sites.<\/p> High-rise apartments are typically located in larger markets, feature 100+ units, and are professionally managed.<\/p> The number of stories is less specific for high-rise buildings, however, once you exceed 10-12 stories, most markets will regard the building to be a high-rise.<\/p> A skyscraper is a high-rise building that has more than 40 stories and reaches a certain height.<\/p> Office buildings, like multifamily properties, are classified as low, mid, or high rise depending on their size.<\/p> Office buildings are typically classified as Class A, Class B, or Class C.<\/p> These classifications are all relative and heavily influenced by contexts, such as the location of the building and the health of its surrounding market.<\/p> The Class A <\/strong>buildings are the best of the best in terms of construction and location.<\/p> Class B<\/strong> properties may have high-quality construction but are in a less desirable location.<\/p> Class C<\/strong> properties may be dilapidated and in an unfavorable location.<\/p> Office buildings in a central business district (CBD) are in the heart of a city.<\/p> These buildings would include high rises in downtown areas in larger cities like Chicago or New York, as well as in some medium-sized cities like Orlando or Jacksonville.<\/p> This type of suburban office space typically consists of mid-rise structures ranging in size from 80,000 to 400,000 square feet and located outside of a city center.<\/p> Suburban office parks, which assemble several different mid-rise buildings into a campus-like setting, are also common in cities.<\/p> The size of industrial properties can also vary significantly depending on their specific use-cases.<\/p> This industrial property category is really a special use category that most large manufacturers would fall under. These properties are heavily customized with machinery for the end-user and usually require extensive renovation to re-purpose for another tenant.<\/p> These structures are much simpler than heavy manufacturing properties and can usually be easily reconfigured.<\/p> Storage, product assembly, and office space are all common applications.<\/p> This is an industrial property that can be easily converted and typically includes a mix of industrial and office space.<\/p> Flex space can also be considered mixed-use, which we’ll go over in more detail below.<\/p> These properties are typically very large, ranging from 50,000 to 1,000,000 square feet.<\/p> These properties are frequently used for the regional distribution of products. They also require easy access by trucks entering and exiting highway systems.<\/p> Strip centers are smaller retail properties that may or may not have anchor tenants. An anchor tenant is simply a larger retail tenant that serves to draw customers into the property.<\/p> Anchor tenants include Wal-Mart, Publix, and Home Depot. Strip malls typically house a mix of small retail stores such as Chinese restaurants, dry cleaners, nail salons, and so on.<\/p> Community retail centers typically range in size from 150,000 to 350,000 square feet.<\/p> They are occupied by a number of anchors, such as grocery stores and drug stores. Furthermore, it is common to find one or more restaurants in a community retail center.<\/p> A power center typically has several smaller, inline retail stores, but it is distinguished by the presence of a few major box retailers, such as Wal-Mart, Lowes, Staples, Best Buy, and so on.<\/p> Each big box retailer typically occupies between 30,000 and 200,000 square feet, and these retail centers typically contain several out parcels.<\/p> Malls range in size from 400,000 to 2,000,000 square feet and typically have a few anchor tenants such as department stores or big-box retailers such as Barnes & Noble or Best Buy.<\/p> Most larger retail centers have one or more out parcels, which are plots of land set aside for specific tenants such as fast-food restaurants or banks.<\/p> Full-service hotels are typically located in central business districts or tourist areas and include well-known brands such as Four Seasons, Marriott, and Ritz Carlton.<\/p> Hotels in the limited-service category are typically boutique properties. These hotels are typically smaller and do not offer amenities such as room service, on-site restaurants, or convention space.<\/p> These hotels have larger rooms, small kitchens, and are intended for people staying for a week or more.<\/p> Mixed-use properties, while distinct in their own right, can actually be a combination of any of the aforementioned types of commercial property. Retail\/restaurant properties with offices or residences atop are the most common type of mixed-use property, particularly in cities.<\/p> Consider a typical downtown high-rise building; chances are, the asset is mixed-use. Mixed-use properties are typically some combination of office, residential\/multifamily, retail, and\/or industrial.<\/p> Greenfield land is undeveloped land, such as a farm or pasture. This category would also include various types of agricultural land, such as orchards, animal farms, ranches, and more.<\/p> Infill land is located in a city that has already been developed but is now vacant. It is solely associated with the development of real estate in urban areas.<\/p> Brownfields are parcels of land that were previously used for industrial or commercial purposes but are now available for re-use.<\/p> These properties are generally environmentally harmed or are suspected of being so, as a result of previous commercial uses.<\/p> The above real estate categories cover the most common types of commercial real estate. However, there are numerous other types of commercial real estate that investors construct and own.<\/p> This is where the concept of “special purpose” property comes into play. It is, in essence, the CRE miscellaneous classification. Amusement parks, bowling alleys, parking lots, stadiums, theaters, zoos, and many other special-purpose properties are examples.<\/p> While there are dozens of words unique to commercial real estate investing, preferred returns and equity split are two key ideas that will be discussed throughout this study.<\/p> This is a type of return in which the sponsor pays the investor a fixed rate of return that might range from 5% to 10% or more. Preferred returns are usually paid quarterly, but they can also be paid monthly or annually.<\/p> When a portion of the property’s equity from appreciation or increased value is split between the sponsor and the investor based on an agreed-upon percentage, this is referred to as an equity split.<\/p> The investor does not actively own or manage the property in passive real estate investments. Passive investment often produces income in the form of a dividend, preferred return, equity split, or a mix of the three.<\/p> The following is a basic overview of the numerous ways to invest in commercial real estate passively. Each type of passive commercial real estate investment has advantages and disadvantages, so do your research before investing.<\/p> REITs are one of the most straightforward ways to invest in commercial real estate. A real estate investment trust (REIT) pools money to buy and manage several commercial buildings effectively, and it pays dividends to investors. REITs are eligible for special tax breaks if they send out 90% or more of their earnings as dividends to their shareholders, making them a solid source of passive income.<\/p> There are two types of REITs: Equity REITs and mortgage REITs. Shares of both types can be purchased through a brokerage account (for public REITs) or directly from the REIT (for private ones). The most popular option is publicly-traded REITs, which may be purchased for as little as a few hundred dollars.<\/p> Rather than selecting and purchasing individual REIT shares, you can participate in several REITs through a real estate exchange-traded fund (ETF). A fund manager selects a portfolio of real estate securities to invest in. This can comprise a number of REITs in various commercial areas.<\/p> Real estate exchange-traded funds (ETFs) reduce risk by spreading your investment across several firms and sectors.<\/p> For approved investors, CRE crowdfunding is a passive investment alternative. Investors can use crowdfunding platforms to connect with third-party investors or developers that have an investment opportunity that needs funding. Most crowdfunding platforms evaluate the investment and the sponsor before adding them to the platform, but you should do your own research on the opportunity and the sponsor.<\/p> CRE crowdfunding options can be accessed by investors for as little as a few thousand dollars, however, others demand hundreds of thousands. While the returns are often better than those of a REIT or real estate ETF, there is less liquidity and more risk with crowdsourcing. The majority of crowdfunding possibilities have maturities ranging from two to five years. During such time, the investor is unable to withdraw their funds from the transaction.<\/p> Another passive alternative is to collaborate as a financial partner with an active CRE investor. You are a silent, passive partner who contributes to the down payment or cash purchase of the property in exchange for a preferred return, equity share, or a combination of the two. This is similar to crowdfunding, except that the number of partners is smaller and the returns are bigger. But there is also a greater risk.<\/p> Equity and financial partners are popular in the real estate industry, particularly in CRE. These changes, however, are not well-publicized. The majority of equity opportunities are discovered through established contacts with active investors. It is critical that you undertake your own due diligence on the investment and the investor. They are in charge of the LLC, the property, and your money, so you must have faith in their abilities to manage the investment successfully.<\/p> Active real estate investments are those in which the investor actively manages the investment. This often entails owning a piece of the investment as well as bearing some or all of the risk and obligation. While this is not always the case, active investing typically outperforms passive investing. Active investments generate revenue in two ways:<\/p> If you actively invest in commercial real estate, you are responsible for finding, funding, acquiring, managing, and disposing of the property. While you may have financial partners, investors, a third-party management business, or a team of individuals on your side, you are ultimately accountable for the investment’s success or failure.<\/p> Most active CRE investors specialize in a specific industry. They may exclusively purchase multifamily residences or concentrate on office complexes. Determine the following before purchasing a commercial property:<\/p> Here’s how to start actively investing in commercial real estate.<\/p> Once you’ve decided on a sector and a location, you’ll want to look for investment opportunities to explore. Loopnet, Crexi, Craigslist, and your own direct mail campaign are all good places to look for properties offered for sale through a commercial real estate broker.<\/p> If the property is listed with a broker, the broker would normally submit an offering memorandum (OM) outlining the property’s present performance as well as its pro forma, or the prospective revenue the property can earn when managed and leased efficiently. While this information is helpful, it is your responsibility to confirm the projections and current spending.<\/p> The majority of offers are based on the property’s net operating income (NOI) and cap rate.<\/p> If the investment appears to be viable, the next step is to submit a letter of intent (LOI). This is a one- or two-page paper that summarizes:<\/p> An LOI is not legally binding, but it continues the buyer and seller’s due diligence process on temporary terms. After the buyer has completed their due diligence, they will be able to engage in a formal contract. Consult with an attorney before signing any contract to ensure that it contains all of the relevant provisions and conditions and effectively protects both parties.<\/p> An LOI is not legally binding, but it continues the buyer and seller’s due diligence process on temporary terms. After the buyer has completed their due diligence, they will be able to engage in a formal contract. Consult with an attorney before signing any contract to ensure that it contains all of the relevant provisions and conditions and effectively protects both parties.<\/p> You should arrange funds as soon as the contract is signed. There are a variety of commercial real estate loan options available:<\/p> When approving loans, most banks consider two factors:<\/p> While the property is the most important factor in the loan, banks also look at the investor’s business plan, creditworthiness, experience, and net worth to determine whether or not they are qualified to repay the loan.<\/p> It is not uncommon for CRE loans to require the investor to be a personal guarantor, assign a life insurance policy, or use other property as collateral, such as a primary residence.<\/p> Commercial real estate, like residential real estate, has an examination period. This term, which can be negotiated to be as short as 15 to 60 days, allows the buyer to conduct inspections and undertake due diligence on the property.<\/p> Buyers can order a variety of reports:<\/p> The lender is the one who orders the majority of inspections. As a result, before ordering any surveys or inspections, you should look into financing options. This is also the time when the buyer verifies information on the property’s operation, such as income deposits, rental rates, vacancies, preceding tax returns, and so on.<\/p> During the inspection time, the buyer has the option to renegotiate or cancel the contract, often without penalty.<\/p> The property will be closed with a title firm or attorney once funding is received and the inspection period has expired. It is then the investor’s responsibility to manage the property. This can involve things like <\/p> Owning a CRE property frequently necessitates a significant amount of work and constant supervision. However, it can result in a large reward.<\/p> Depending on the type of investment, income from commercial real estate is taxed differently. Once you’ve decided on the best way to invest in CRE for you, look into how that investment is taxed and consult with a tax advisor.<\/p> One of the most significant advantages of commercial real estate is the low cost of leasing. Commercial real estate can have remarkable returns and significant monthly cash flows in places where the quantity of new construction is either limited by land or by law. Industrial buildings typically have cheaper rents than office towers, but they also have lower overhead expenditures.<\/p> Commercial real estate also benefits from tenant lease terms that are far longer than those in residential real estate. As long as long-term tenants occupy the building, this extended lease period provides the commercial real estate holder with significant cash flow stability.<\/p> Commercial real estate, in addition to providing a consistent and lucrative source of income, has the potential for capital appreciation as long as the property is well-maintained and kept up to date. And, like all types of real estate, it is a distinct asset class that can provide an effective diversification alternative for a well-diversified portfolio.<\/p> Most people who desire to invest in commercial real estate directly are put off by rules and regulations. Commercial property taxes, purchase mechanics, and maintenance responsibilities are hidden beneath layers of legalese. These standards differ depending on the state, county, industry, size, zoning, and a variety of other factors. Most commercial real estate investors have specialized knowledge or a team of people that do.<\/p> Another impediment is the heightened risk that comes with tenant turnover, which is especially important in an economy where unexpected retail closures leave properties vacant with little warning.<\/p> When it comes to dwellings, one tenant’s facility needs frequently mirror those of prior or prospective occupants. In the case of a commercial property, however, each renter may have quite diverse needs that necessitate significant renovations. The building owner must then modify the area to meet the particular trade of each tenant. Due to the cost of improvements for incoming tenants, a commercial property with a low vacancy but high tenant turnover may nevertheless lose money.<\/p> Buying a commercial property is a significantly more expensive proposition for those wishing to invest directly than buying a residential home. Furthermore, while real estate, in general, is one of the more illiquid asset classes, transactions for commercial buildings proceed at an exceptionally slow pace.<\/p> The commercial real estate industry in the United States suffered greatly during the 2008-2009 crisis, but it has been experiencing annual improvements since 2010. These gains have contributed to the recovery of nearly all recession-era losses.<\/p> Other signs, however, suggest that the commercial property market has peaked in the post-recession expansion cycle. According to Ten-X Growth, a California real estate agency, commercial property prices closed in 2018 up just 1% from 2017.<\/p>Types of Commercial Real Estate <\/h2>
#1. Multifamily<\/h3>
Duplex\/Triplex\/Quadruplex<\/h4>
Garden Apartments<\/h4>
Mid-Rise Apartments<\/h4>
High-Rise Apartments<\/h4>
#2. Office<\/h3>
Class A, B, and C office buildings<\/h4>
Central Business District (CBD)<\/h4>
Suburban Office Buildings<\/h4>
#3. Industrial<\/h3>
Heavy Manufacturing<\/h4>
Light Assembly <\/h4>
Flex Warehouse<\/h4>
Bulk Warehouse <\/h4>
#4. Retail<\/h3>
Strip \/ Shopping Center<\/h4>
Community Retail Center<\/h4>
Power Center<\/h4>
Regional Mall<\/h4>
Out Parcel<\/h4>
#5. Hotels<\/h3>
Full-Service Hotels<\/h4>
Hotels with Limited Service<\/h4>
Extended Stay Hotels <\/h4>
#6. Mixed Use<\/h3>
#7. Land<\/h3>
Greenfield \/ Agricultural Land<\/h4>
Infill Land<\/h4>
Brownfield Land<\/h4>
#8. Special-Purpose<\/h3>
Basic Terms In Commercial Real Estate<\/h2>
Preferred returns: <\/h3>
Equity Split: <\/h3>
Passive Commercial Real Estate Investments <\/h2>
Real Estate Investment Trusts (REITs) <\/h3>
Real Estate Exchange-traded Fund (ETF)<\/h3>
Crowdfunding<\/h3>
Participate as an equity or financing partner.<\/h3>
Active Commercial Real Estate Investments <\/h2>
How to Buy and Manage a Commercial Real Estate Property on Your Own<\/h2>
#1. Evaluate potential investment opportunities<\/h3>
#2. Submit a Letter of Intent (LOI)<\/h3>
#3. Obtain funds<\/h3>
#4. Conduct a thorough inspection and due diligence<\/h3>
#5. Complete the transaction and begin managing the investment.<\/h3>
Commercial Real Estate and Taxes<\/h2>
Benefits of Commercial Real Estate<\/h2>
Commercial Real Estate Disadvantages<\/h2>
Forecasts for Commercial Real Estate<\/h2>