Commercial real estate investment has a hard learning curve. Many independent real estate investors can ease their way into diversified holdings by focusing on residential markets once you’ve purchased a primary residence, investing in rental homes or flips is less of a jump. But commercial real estate investments require a completely different set of skills, insights, and timelines. Before you start negotiating your first transactions, we recommend learning more about different types of commercial real estate investments, how to find the right lenders and agents, and setting the groundwork for effective investments. In this guide, you’ll read about:
- Different commercial real estate specializations
- The pros and cons of investing in commercial real estate
- How to find and fund investments
- Why finding the right commercial real estate agent is essential
The Different Types of Commercial Real Estate Investments
Commercial real estate is made up of larger properties used to conduct business, such as stores, shopping centers, offices, and more. This is different from residential real estate, which comprises single-family residential properties (i.e., houses). The five broad categories of commercial real estate investments are:
Commercial real estate investors can also choose between different investment approaches, not just different types of properties. For example, you could invest and hold to gain rental income, flip the properties to immediately regain your capital and profits, or invest in publicly-traded real estate investment trusts (REITs). Generally, people consider the first two options to be the core types of commercial real estate investment approaches.
The Pros and Cons of Commercial Real Estate Investments
Just like any investment approach, commercial real estate investing comes with pros and cons. Some of the key benefits of choosing commercial real estate investing are:
- Greater scalability: You’re purchasing larger real estate holdings, so you have more capacity for larger sums of revenue per property.
- Less competition: The residential real estate markets are crowded. Commercial real estate is more specialized, and, once you gain experience, you’ll be in a stronger position.
- Long-term wealth accumulation: Commercial real estate is a great tool for wealth accumulation. While it’s a long-term approach, commercial real estate holdings can create a strong legacy for your family.
- Diversification: Even if your portfolio becomes ‘top-heavy’ with commercial real estate holdings, there are so many different types of commercial holdings that you can easily diversify your properties.
A few cons to consider are:
- Upfront capital demands: Bigger investments require exactly that – a bigger investment. Even with generous lenders, you often need a lot of capital to get started.
- Lack of liquidity: Commercial real estate is more complex than residential real estate. Your holdings will not be easy to liquidate quickly.
- Upfront learning curve: There’s a lot you need to know about commercial real estate investing before you may feel comfortable making your first investment. However, the right advisors, agents, and learning resources can help.
How to Find Commercial Real Estate Property for Sale
There are marketplaces online where you can search for different types of properties, including retail and office buildings, industrial buildings and warehouses, apartment complexes, and mixed-use properties. However, you won’t want to search and buy alone. Before you select a property, there are three steps you should take to ensure you’re choosing the right property for your risk level, capital, and overall portfolio:
- Talk to a real estate attorney: This professional can advise you on how to structure your business to protect your personal assets and keep your business holdings separate from your personal finances. The attorney can also evaluate commercial real estate contracts, which are more complex than residential contracts.
- Discuss your options with different lenders: Commercial real estate lending is very different from residential lending. Shopping around and speaking to different service providers can help you find the right fit.
- Search through a real estate agent: While you can do your own research, especially if you have a network of business professionals with commercial real estate holdings, a certified agent has access to more tools for finding properties and can help compare prospective investments to other recent purchases in the market and neighborhood to ensure it’s a good deal.
Along the way, developing an understanding of how to read market evaluations, reading commercial real estate advice books, and gaining a deeper understanding of your preferred market will help you put the advice of these professionals to good use.
How to Choose Between Commercial Real Estate Properties for Sale
Before submitting an offer on a commercial real estate property, you’ll want to have a clear process for determining if the property offers you the right value and what type of offer you’ll want to put on it. Some of the steps that could go into this process would be:
- Assessing the “comps:” See how comparable properties in the neighborhood and property niche have sold and performed over the past six months.
- Calculating the payback period: Determine how quickly you’ll recoup your upfront investment costs (such as the down payment and closing) on the property, especially if you want to buy and hold the property for rental income.
- Determining the stability of the market: While real estate in general is relatively insulated from the ups and downs of the market in a way stock holdings are not, that doesn’t guarantee a return. Evaluate how likely there is to be continued development for the space in the future. For example, a metroplex that’s becoming a business epicenter will likely have a continued demand for office space. However, events like the pandemic show there’s no sure thing.
How to Find a Lender You Can Trust for Financing Commercial Real Estate Properties
Commercial real estate loans are more complex than other loans. Finding a partner who fits your current finances and goals is essential; finding a lender who can evolve with you is even better. Your commercial lender will look into your:
- Business finances, including your business’s credit score and history of performance
- Personal finances
- Property niche and the property itself
As you’re looking for a lender, keep in mind that commercial lenders generally demand a favorable loan-to-value ratio between 65 and 80%. So you’ll need to have enough funding for the down payment before you start applying for approval.
Gain a Solid Foundation of CRE Investment Knowledge Before You Begin
Commercial real estate investing is an extremely versatile and profitable category of investing. But starting with the right knowledge, access to funding, and mindset is essential so you can build long-term wealth without rushing into deals that are too risky. Contact EXtrance today to find more resources for new commercial real estate investors.