Investing in real estate is an excellent way to build wealth. Commercial real estate investing is known to provide some of the highest income streams. If you have been investing in residential real estate for a few years and have been wondering what makes commercial Real Estate a good investment, this guide serves to break down everything you need to know to get started.
Not like their residential counterparts, commercial real estate investing trends are subject to cyclical changes. Though, you could easily proclaim that commercial real estate investing is subjected to more changes than those found in the residential sector. Though, the commercial real estate industry is made up of various sectors: hotel, industrial, retail, multifamily, and office. Consequently, every sector’s expectations are at the mercy of unique demands and needs, not the least of which changes in conjunction with the country’s economy. Well, there are many variables that will inherently impact the performance of any commercial real estate sector, and investors need to be conscious of how they impact current and future trends.
It is worth noting that while commercial real estate was incredibly appealing in the year 2019, it remains too costly for the average investor to consider. Though investing in the commercial real estate sector does come with a higher price tag, one new trend is leveling the playing field that is known as crowdsourcing. The potential to crowdsource a commercial real estate investment is not only becoming more feasible, but it has become more common than ever. The capability to crowdsource funds for investing in commercial real estate now provides real estate investors the possibility to transition from residential deals into commercial deals, which bodes well for a bright future. That said, it is fair to think we will start to see more small investors breaking into the commercial world.
What Qualifies as ‘Commercial Real Estate?
Commercial real estate is a property that is typically leased out for retail and business purposes. Investing in commercial real estate involves the buying or development of properties that have been designed with the intent of commercial home tenants. Unlike a residential real estate investor, what commercial real estate investors do is that they lease out and get rent from the businesses that reside in their properties. It must also be noted that raw land purchased for the development of the commercial property is also included in this definition. Commercial properties can usually be categorized into five main types.
The five types of Commercial Real Estate
While we go into the details of how to invest in commercial real estate, it is essential to understand the many types of commercial properties. This is how you can start thinking about the commercial asset type that interests you. Commercial properties serve a quite broad range of purposes but are usually grouped into the following types:
- Special Purpose
One of the popular commercial real estate type is retail buildings. These properties, which range from malls and community retail centers to restaurants and banks, are often located in urban areas. The size and dimensions of these real estate properties can extend anywhere from 4,000 square feet to 340,000 square feet.
The most common commercial real estate type is office space. These buildings, which may range from single-tenant offices to skyscrapers, are defined by one of three categories known as Class A, Class B, and Class C.
- Class A commercial real estate properties are mostly newly built or extensively renovated buildings located in prime areas with easy access to major facilities. They are normally managed by professional real estate management corporate companies.
- Class B commercial real estate properties are considered as older buildings that require some type of capital investment. Although they are well-managed and maintained, these properties require minor upgrades and repairs—making them a popular target for investors.
- Class C commercial real estate properties are used for redevelopment opportunities. They are commonly poorly located, require some type of major capital investments to improve out of date infrastructure, and their high vacancy rates are more than higher-classed buildings.
Industrial buildings are mostly geared towards manufacturing industries, from warehouses to large manufacturing sites, as they offer spaces with docking availability and height specifications. Plus, these commercial properties generally lend themselves more to investment opportunities.
Multifamily properties are comprised of luxury apartments complexes, high-rise condominium units, and smaller multifamily units. Property is called multifamily real estate at any time. It consists of more than one unit and can also be considered as a commercial property if it consists of more than four units. Most residential investors get their start in commercial properties by extending into larger multifamily properties. Residential tenants tend to have lesser lease terms than retail and office tenants, so tenant turnover is a factor that should be considered.
In general, special purpose properties are built for a specific use, so much so that it would be quite difficult to repurpose the property for another use. Schools, car washes, and self-storage facilities are all examples of special purpose properties. The tourism industries represent a large proportion of special purpose real estate as well. Common examples within the industry include amusement parks, hotels, airports, and sports stadiums.
Mixed-use development properties are also widespread in the commercial real estate sector and continue to grow in demand. These properties represent different uses, such as retail, residential, and the public sector. A mixed-use building could have, for example, shops and services on the first floor with apartment units on the upper floors.
Benefits of Commercial Real Estate Investing
Investing in commercial real estate can be worthwhile, both financially and personally. The objective of investing in the commercial real estate sector is for future security and wealth; others use it for tax benefits and investment portfolio diversification.
A commercial investor can also take advantage of the following benefits:
- Higher Income: The hallmark advantage of investing in commercial real estate is a higher potential income. Generally speaking, commercial properties have a greater return on investment, an average of five to ten percent, while single-family properties obtain between one and five percent. Secondly, commercial real estate gives a lower vacancy risk, as properties tend to have more available units. Plus, commercial leases are usually longer than those you will find in residential real estate. This indicates that commercial real estate owners have to deal with far lesser tenant turnover.
- Cash Flows: Commercial real estate has one very clear benefit: a relatively consistent stream of income due to longer lease terms. Plus, commercial properties often have more units than residential properties, which means you can obtain economies of scale and increase your income streams much more rapidly. This is known in the industry as a triple net lease, many commercial tenants also pay the maintenance costs, building’s real estate taxes, and property insurance, thus enhancing your owner benefits.
- Less Competition: Another benefit associated with commercial real estate is quite less competition, because of the noted difficulty of commercial investing, the commercial space leads to be less saturated with other investors.
- Longer Leases: Perhaps one of the greatest perks of commercial real estate is the attractive leasing contracts. Commercial buildings usually have longer lease agreements with tenants compared to residential properties, which, as previously stated, offers investors moving returns and significant monthly cash flow. In such cases, lease agreements for commercial properties are signed for multiple years.
Commercial real estate investing gives investors an array of possibilities and advantages that other investment strategies do not. Once the advantages of commercial real estate investing get recognized, the next step is to dive in.