Commercial real estate has become a hot topic in the real estate world. With its many advantages like steady cash flow, high-income potential, and low vacancy risks, it’s a rewarding opportunity for the savvy investor. Do you have what it takes to make it in the world of commercial investing? This beginner’s guide to commercial real estate will walk you through the types of commercial properties, benefits of commercial investments, and how to get started in the market.
Types of Commercial Properties
Commercial real estate is a relatively vague term. Someone in commercial real estate could work with a variety of properties, but the commonality between them all is that they are used for business purposes. The different types of commercial properties are:
- Office space – When investing in commercial real estate, office space is the most common property type. Properties with office space can vary from single-tenant buildings to large high-rises.
- Retail space – A retail investment space can be anything from a strip mall to a shopping complex with shops and restaurants to a single retail property. These are more popular in highly populated, urban areas.
- Multifamily – Commercial real estate isn’t just comprised of businesses but includes multifamily housing as well, such as apartment complexes and condominiums. If any residential property has more than four units, it is considered a commercial property.
- Industrial – From warehouses to manufacturing plants, industrial real estate is a bit more obscure but can often lead to a high return on investment.
- Special purpose – Properties that aren’t designed for business or multifamily purposes tend to fall under the “special purpose” category and are designed for a specific use such as a bowling alley, hotel, storage facilities, and more.
When getting into commercial real estate, you need to determine which type of investment property you plan to tackle. Each type will require a different strategy when beginning your investment journey.
Benefits of Investing in Commercial Real Estate
There are many reasons savvy investors find themselves in the commercial real estate market. Whether you’re looking to diversify your investment portfolio or build your wealth, commercial investing is an ideal choice. As a commercial investor, you’ll experience many of the following advantages:
High Potential Income
If the idea of real estate investments sounds intriguing to you, it’s important to understand the additional potential income you’d be able to bring in. In most instances, commercial investments will have a higher return on investment than residential investments. Not only will you make more from your commercial tenants, but you’ll often have fewer vacancies to deal with — meaning you’ll have a more consistent income and fewer tenants turning over.
No one wants to get into an industry that is completely saturated with other investors. If you do that, it’ll be much harder for you to make a dent in your local market. The world of real estate is relatively competitive. If you prefer a less competitive and less saturated market, commercial investments might be the right choice for you.
Longer Lease Terms
As a property owner, your goal is to have as few vacancies as possible. The more tenants you have occupying your spaces, the higher your potential income. A major benefit of the commercial real estate market is that lease agreements tend to be for longer periods in comparison to residential properties. This allows you to have more consistent cash flow, sometimes for multiple years at a time!
When working with residential real estate, business hours can become muddled when fielding calls from tenants at all hours of the day. With commercial real estate, you don’t usually have to work 24-hours a day, seven days a week. In this segment of the industry, you tend to share the same working hours as your tenants. This makes it a lot easier for you to handle tenant communication, maintenance requests, and other inquiries from your tenants during the standard working day.
There are many benefits for investors looking to get into the commercial real estate market that you won’t experience in any other industry. Now that you understand the advantages, we’ll cover the fundamentals you need to know to get started.
Commercial Real Estate Fundamentals
Before diving into the commercial real estate market, you need to do the proper research to ensure you understand the ins and outs. The answer to “how to invest in commercial real estate” might differ slightly from investor to investor, but the fundamentals are the same. Looking to get started in commercial investing? Check out our tips below.
Residential vs. Commercial Investing
Whether you’re new to the world of real estate or you’ve been dabbling in residential investments and are looking to make the switch to commercial, it’s important to understand the differences between these two niches.
Residential investors work with individuals looking for a single-family residence, while commercial investors work with a variety of property types such as multi-family, office, and retail space. Because the types of properties vary so much on the commercial side, investors must be comfortable with the legality of the investment deals. Investors also need to have an understanding of who their desired tenants are and if their properties will suit those individuals’ needs. Understanding of marketing is an absolute must to gauge how well the property is going to perform.
If you’re looking for investment opportunities with higher earning potential, then commercial real estate is the path to take. While residential properties are easier to occupy or sell than commercial properties, commercial investments tend to earn a higher commission — leading to a much higher earning potential.
Learn How to Accurately Analyze Commercial Comparables
Unlike residential real estate where properties are valued by their square footage and comparable in their area, commercial properties are analyzed a bit differently. Correctly analyzing commercial comparables, otherwise known as “comps,” allows investors to determine the market value of a property.
Commercial comps don’t rely on the sales price or square footage, but instead, they use other methods to compare the capitalization rate (more on this below) of similar properties in the area. To do this, investors will divide the property’s sale price by the net operating costs. Doing this allows investors to get an idea of what the annual rate of return would be.
Be Able to Perform the Necessary Calculations
Math not your strong suit? Don’t stress. While there are a variety of calculations you’ll need to do when investing in commercial real estate, we’ve broken down exactly what you need to know and how to perform the necessary calculations.
- Gross Revenue – If your commercial property was fully occupied, how much revenue would you make? Determining this is how you determine what your gross revenue is.
- Vacancy – A property’s vacancy is calculated based on a percentage of the gross revenue.
- Operating Expenses – Consider all the expenses needed to operate the commercial property. You will want to factor in costs such as maintenance, janitorial fees, repairs, management fees, utilities, and property taxes.
- Net Operating Income – The net operating income is used to determine how much an investor will gain from the commercial investment after subtracting operating expenses. To calculate the net operating income, take your gross revenue and subtract out the operating expenses.
- Capitalization Rate – To determine if a commercial property is a worthwhile investment, investors calculate the capitalization rate. This provides an estimate of future profits. To determine the cap rate, take the commercial property’s net operating income and divide this by the market value.
- Cash on Cash – If financing a commercial investment, cash on cash will be an important metric for you to track. Cash on cash is used to calculate the cash income earned on the cash invested in a property to provide an accurate rate of return on the investment.
- Internal Rate of Return – One of the most important aspects of commercial real estate is being able to track how well your investment is performing. The internal rate of return helps investors understand if their property’s value is growing or if they should move to a new opportunity.
These are only a few of the many metrics you’ll want to track when investing in commercial real estate. By understanding these, you’ll set yourself up for successful investing.
Don’t Be Afraid to Get Help from a Property Management Company
When investing in commercial real estate is your top priority, you can’t let the day-to-day operations of your property fall to the wayside. Instead of juggling the daily management of the property, hand the reins over to a commercial property management company that can offer their assistance. A property manager will be able to help investors with their leasing efforts, tenant retention, building maintenance, and financial reporting.
While commercial investing can seem intimidating to the novice investor, it doesn’t have to be. By understanding the core fundamentals and benefits of commercial real estate, you’ll be able to successfully piece together an investment strategy that is second to none.