Things You Need to Know Before Investing in Commercial Real Estate

Investing in any property, whether commercial or residential, is a great way to build wealth. Commercial real estate investments, in particular, are well known for their ability to provide some of the highest sources of income. If you’ve been thinking of investing in commercial real estate or have been wondering how to get started in commercial real estate, you’ve come to the right place! Here’s everything you need to know. 

What is Commercial Real Estate? 

A property typically leased out for business or retail purposes is known as commercial real estate. Investing in commercial real estate means that you will be housing only commercial tenants, not residents. Having said that, many residential property investors step into commercial real estate investments by purchasing multifamily properties. Before we delve further into the essentials of getting into commercial real estate, let’s first understand the types of commercial real estate.   

Types Of Commercial Real Estate Investments 

Commercial properties can be broadly categorized into 4 types. These are: 

1. Office

Offices are one of the most common and popular commercial real estate types. They range from single-tenant offices to multi-tenant offices and even skyscrapers. Potential office building investors need to know further that there are 3 subcategories of office spaces: 

1. Category A: Newly built or fully renovated building located in a premium area. 
2. Category B: A building that requires minor repairs and renovations before it can be leased out. 
3. Category C: Commercial office properties that are in dire need of redevelopment fall under this category. These are generally situated in not-so-popular localities and require a lot of capital investment.

2. Industrial

It has been observed that more serious investors generally tend to buy commercial real estate that falls under this category. This type includes manufacturing factories, industrial buildings, and warehouses. 

3. Multifamily

Multifamily real estate comprises condominium units, apartment complexes, and smaller properties with more than one residential unit. 

4. Retail

Strip malls, community retail centers, power centers (AKA big-box centers), regional malls, and retail outlets at out parcels all fall under this type of commercial real estate.   

Apart from these four, there’s another type known as Special Purpose Properties. Bowling alleys, car washes, schools, hotels, daycare centers, churches, fitness and healthcare centers, sports stadiums, self-storage facilities, airports, amusement parks, etc. are all examples of Special Purpose Properties.   

Why Choose to Invest in Commercial Real Estate? 

Investing in commercial real estate typically requires a substantial financial commitment, which can be substantial for an individual retail investor. The most common ways to invest in commercial real estate (CRE) are through real estate investment trusts (REITs) or fractional ownership. 

This approach lowers the barrier to entry for retail investors by reducing the investment amount. However, a smaller investment size doesn’t automatically guarantee a good opportunity. 

CRE investments offer distinct advantages over traditional options: 

• Real estate is largely insulated from market fluctuations, providing stability and a consistent rate of return as a long-term investment. 
• The lock-in period secures your investment and ensures returns. 
• Special-purpose CRE in prime locations can be highly lucrative. They attract a niche segment of tenants and generate ongoing passive income through lease renewals. 

How To Begin Investing in Commercial Real Estate 

Investing only in commercial real estate is possible, but the high costs often make it challenging for a single investor to cover the necessary amount. A popular alternative is investing through REITs or fractional ownership. 

REITs function similarly to mutual funds. Fund managers handle the REIT, and your investment becomes part of a pool spread across multiple assets. These assets are chosen based on historical performance and market trends. Returns from all assets are combined and distributed to investors according to their share in the REIT fund. 

Fractional ownership allows like-minded investors to pool their money to own a share of an asset. The minimum investment is usually in multiples of lakhs. Depending on their risk tolerance and funds, individual investors can own one or more fractions of an asset, giving them a portion of ownership. Returns from rent and capital appreciation are distributed according to each investor’s ownership percentage. 

The key difference between these two methods is control. In a REIT, a portion of your investment might sit idle in a non-performing asset, with the only solution being to withdraw completely. In contrast, fractional ownership offers more flexibility, allowing you to stay invested in profitable assets while selling, trading, or stopping your ownership in a non-performing asset. 

10 Commercial Real Estate Investment Strategies 

Before you purchase commercial real estate, here are a few factors you should consider: 

1. Property Type 

Investing in commercial property involves more risk than residential, as success depends on the performance of the tenants’ businesses rather than just comparable sales. The most common types of commercial properties are: 

• Office 
• Industrial 
• Multifamily 
• Retail 
• Hotels 
• Mixed-use spaces 

Market conditions also play a crucial role in the success of a commercial property.  

2. Location 

Proximity to roads, railroads, major highways, airports, and seaports significantly boosts an asset’s value and potential appreciation over time. A well-connected location near harbors and ports is ideal for tenants involved in manufacturing, especially those who export or import goods internationally. 

The same location may not be ideal for businesses in software operations. When investing in a major urban market, actively monitor the micro-markets around your asset for changes that could impact your investment. 

3. Risk Assessment  

You may know how to invest in real estate, but investing in commercial real estate is altogether a different ball game. Each type of commercial property has its own specific set of risks and challenges and requires proper investment and risk assessment. 

4. Current Tenants  

Existing tenants’ financial condition and current lease terms can reveal much about the asset’s long-term viability and the potential benefits of your investment. Historical data on lease terms and vacancy rates will help you prepare for any gaps in tenancy during your investment period. General-purpose office spaces often have higher occupancy rates, but specialized warehouses or laboratories may offer better capital appreciation and more stable tenancy. Grade A tenants usually have longer lock-in periods and tend to give the best ROI. 

5. Building Quality  

The previously mentioned categories of office buildings decide your total expenditure. The more repairs an asset requires, the more you will invest. 

6. Market Dynamics 

Keeping yourself abreast of which businesses are up-and-coming, which businesses are at the top of their game, and which businesses are stirring the economy, is an excellent way to decide which commercial real estate to invest in. 

7. Budget and Financing 

Evaluate your cash flow and budget carefully to identify the best deals for your goals. This approach will clarify where you can invest, the size of the asset, and the type of asset that fits your plan. 

Commercial deals are expensive and require long-term capital commitments. They often involve complex arrangements typically available only to high-income individuals or asset-rich accredited investors. 

To start, review your: 

• Cash flow 
• Financing options 
• Financial commitments 
• Projected cash flow 
• Cash reserves for unexpected costs like renovations, maintenance, or property taxes 

Assessing your finances can help you determine your approach to entering a deal. For instance, a high-income earner might join syndication as a general partner, while a newcomer seeking to minimize cash risk could become a shareholder in a REIT. 

8. Investment Purpose 

Having a clear action plan and defining your investment purpose is essential. Are you investing for capital gain or cash flow?  

For example, if you’re focused on cash flow, a multifamily building could be ideal, offering steady rental income from multiple residents. If you aim for capital gains, converting an abandoned building into office space might be smart. 

By determining your purpose, you can strategize effectively. 

9. Local and State Laws 

Familiarize yourself with the local and state codes that govern commercial real estate in your area of interest. Key considerations include: 

• Zoning 
• Rental laws 
• Building codes 
• Noise restrictions 
• Tax values 

You can avoid hefty fines and future inconveniences by complying with these legal requirements. 

10. Property Management 

Investing in commercial real estate requires navigating complex legal, economic, and financial processes. As an investor, you should decide how involved you want to be in managing the asset. 

Many investors choose to hire a reputable property management company like Beach Front Property Management, ensuring that day-to-day operations, tenant relations, and property maintenance are handled smoothly.  

Invest in Commercial Real Estate with BFPMInc.

Getting into commercial real estate might seem challenging and intimidating. But with Beach Front Property Management experts by your side, you can know for sure that your investments will be in good hands. From searching for the right commercial property to inspections, leasing, ADA compliance, maintenance, accounting, and marketing, we’ll be with you every step of the way. 

Read our related blog here:

The Ultimate Guide to Corporate Housing: Everything You Need to Know