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In This Article
- What is Commercial Real Estate Investing?
- Commercial vs Residential Investing: What's the Difference?
- Types of Commercial Investments
- What Is Owner-Occupied Commercial Real Estate?
- Benefits of Commercial Real Estate
- Risks to Commercial Real Estate
- 6 Commercial Loan Options
- Frequently Asked Questions: Commercial Real Estate Investing
- Commercial Investing: 3 Steps to Getting Started
- The Bottom Line: Commercial Real Estate Investing
Whether you are a real estate investor looking for the next challenge, or a real estate investor looking for opportunity and a high rate of return, commercial real estate is one investing option.
Commercial real estate comes with its own advantages and disadvantages, and there are unique opportunities to be found in its niches, many of which just may be in your local area.
In this article, we will explore:
- What commercial real estate investing is
- How commercial real estate investing differs from residential investing
- Benefits and risks of commercial of investing in business buildings
- Commercial loan options
- And more
If you’re ready to learn the basics of commercial real estate investing, and whether or not investing in business buildings is right for you, let’s get started.
What is Commercial Real Estate Investing?
Commercial real estate investing involves an investment in business buildings or non-residential real estate only used for business purposes.
Commercial real estate offers investors the opportunity to earn higher cap rates — the net operating income divided by the present market value of a property — than residential usually affords.
Another advantage of commercial real estate investing is the ability to benefit from other industries besides housing.
For example, an investor looking to benefit from the growth of Amazon and e-commerce can look for warehouse investment opportunities.
That said, there are some obstacles to face, including commercial real estate property generally requires a significantly larger investment than residential.
It will likely require professional property management, too.
There are certain property types with commercial investing are subject to more economic risk than residential investing. The loss of a tenant may pose a threat as well.
We’ll look at the advantages and disadvantages of commercial real estate more in depth later on in this article. Next, we’ll look at the difference between commercial and real estate investing.
Commercial vs Residential Investing: What's the Difference?
The most important difference between commercial real estate investing is the method of valuation.
Valuation of residential (including investment property not considered commercial multifamily) is based on comps, or comparison sales.
Comparison sales are recent transactions of similar properties in similar areas.
While commercial real estate valuations can use a market-based methodology, they are more likely driven by net operating income and cap rates.
As a commercial investor, you will focus on the profitability of the commercial property, which isn’t the case with a residential property.
Types of Commercial Investments
There are several types of commercial investments, including the following:
- Real Estate Syndication
We’ll look at each type of commercial investment next.
This includes residential properties, such as apartment buildings and also mixed-use buildings (residential and retail).
Multifamily properties range from high-rise luxury apartments to subsidized mixed-income housing.
Multifamily generally works on yearly lease agreements and provides an investor diversification, meaning you should not be hurt by a single tenant leaving or falling into delinquency.
Similar to multifamily, office properties can range from skyscrapers to small medical buildings and include lease terms from 3-5 years.
Offices give an investor security with longer lease terms, but can face a risk if a single tenant who utilizes much of the space were to leave.
Office space may sometimes require specific build-outs to meet a particular tenant's needs.
Retail may vary from small shopping plazas to large malls or urban center properties.
Typical lease length is 3-5 years or longer.
This includes various property types such as:
- data centers
- cold storage facilities
Leases are longer-term, typically 5-10 years.
These properties often require significant build-outs centered around logistics and utility needs.
Real Estate Syndication for Commercial Properties
Also known as property syndication, real estate syndication is an option when you as a commercial real estate investor want to acquire commercial real estate, but you do not have the funds to invest alone.
With real estate syndication, you have the opportunity to partner with other investors — allowing you to spend far less than you would buying a commercial property alone — to purchase the property and turn it into a revenue-generating investment.
What Is Owner-Occupied Commercial Real Estate?
While investing in commercial real estate, many beginner real estate investors may wonder what owner occupied commercial real estate is and how it associates with commercial real estate investing.
Simply put, owner-occupied commercial real estate is an investment property occupied by one of the building’s owners.
If you purchase an entire warehouse or strip mall and occupy one storefront, it would be considered an owner-occupied location — this is an important distinction because an owner-occupied property is eligible for special financing, such as SBA 504 loans.
Benefits of Commercial Real Estate
There are substantial benefits to investing in business buildings. They include:
Purchasing a commercial real estate property can generate significant revenue, and one of the best ways to generate income quickly is to lease each unit on your property.
The goal is for your monthly lease payments to cover any outgoing expenses while still leaving you with plenty of cash.
Once you purchase commercial real estate, you will open the door to substantial tax benefits, including the ability to shield a considerable amount of your revenue stream.
We recommend consulting an experienced tax advisor to help you pay less taxes legally.
Risks to Commercial Real Estate
Commercial real estate is not entirely without risk. Some potential pitfalls of investing in business buildings include:
Risk of Default
Even though your commercial property will have plenty of equity, all of those loans will be due eventually.
Be sure not to overstretch your assets.
Doing so can leave you in hot water with investors and financial institutions.
Fluctuating Interest Rates
Many commercial real estate financing options include “floating” interest rates.
The word “floating” means that they will fluctuate. A steep increase can ruin profit margins and leave you unable to pay off your loans.
Lack of Liquidity
Commercial real estate is not a liquid investment. Keep in mind that if you need to turn assets into cash quickly, commercial real estate is not the solution.
If you want to get out of a commercial real estate investment, you may have to accept an offer far below market value.
6 Commercial Loan Options
When it comes to investing in commercial real estate, you have many financing options available.
Not every commercial loan will be right for you.
Below, we outline the basic principles of each commercial loan so that you can find the perfect option for your goals.
Commercial Loan Option #1: Small Business Administration (SBA) 7(a) Loan
The U.S. Small Business Administration offers investors the commercial loan option of the 7(a) loan.
This commercial loan is one of the most popular options for purchasing commercial real estate, including working capital for a business owner’s short- and long-term needs.
Commercial Loan Option #2: Certified Development Company (CDC) / SBA 504 Loan
Another commercial loan option: the Small Business Administration offers the SBA 504 loan.
The SBA does not work directly with lenders but partners with lenders and community development firms instead.
The 504 loan includes fixed rates and long repayment terms great for purchasing or renovating real estate.
Commercial Loan Option #3: Conduit Loan
Conduit loans are a unique type of commercial loans.
These commercial loans are commercial mortgages that are bundled together with other similarly structured loans, and sold to investors in the secondary market.
Commercial Loan Option #4: Conventional Loan
Conventional loans are one of the most basic financing techniques that you can use to purchase commercial real estate.
These commercial loans are backed exclusively by financial institutions and typically follow guidelines set by the Federal National Mortgage Association.
Commercial Loan Option #5: Commercial Bridge Loan
Bridge loans seek to “bridge” the gap while you seek out a long-term solution. They will allow you to fund a renovation to your commercial real estate.
Commercial Loan Option #6: Hard Money Loan
Hard money loans are another form of asset-based short-term financing. When you take out this type of loan, you secure the fund with your commercial real estate.
Keep in mind that only private firms or investors issue this type of commercial loan.
While there are many ways to finance a commercial real estate property, a beginner real estate investor should know some key differences from residential mortgages.
Typical commercial loans will require a loan to value ratio from 65% to 80%. In other words, an investor will need 20% to 35% cash.
Another important factor is that a conventional commercial loan will have different terms for amortization and repayment.
While a loan may require monthly payments based on a twenty or thirty-year amortization schedule, there will be a balloon payment where a loan's remaining balance needs to be paid off anywhere from five to ten years after origination.
The balloon payment is often met with proceeds from a sale of the property, but the investor may choose to refinance instead.
Frequently Asked Questions: Commercial Real Estate Investing
Next, we’ll look at the most commonly asked questions with commercial real estate.
Q. What is a good return on investment for commercial real estate?
How a commercial property is financed will significantly affect the investor's cash on cash return. Because of this, it’s difficult to say what a good return on investment is.
Cap rates can be considered, but it should be noted that an investor's actual return will likely be higher than the cap rate due to the leverage involved in financing.
Cap rates for multifamily (which are typically lower than other property types) often range from 4 to 10%.
The goal for any commercial real estate investor, regardless of how the property was financed, is to make more money than the building costs every month, ending with a positive cash flow at the end of each month and each year.
Q. What are some of the tax benefits of commercial real estate?
Commercial real estate allows an investor to utilize a 1031 exchange, which defers capital gains on investment sales (and depreciation recapture) when the proceeds are invested in a new like-kind investment.
Q. What are the best commercial real estate websites?
There are a number of great commercial real estate websites that can help you get started. They include:
No matter which site you choose, or even if you find a commercial property through networking or word of mouth, be sure to have a plan. By sticking to the basics and appropriately assessing risk, you can improve your chances of finding a great property
Commercial Investing: 3 Steps to Getting Started
Interested in jumping into the pool of commercial real estate investing? Next, we’ll look at how you can get started investing in commercial real estate.
Set Clear Goals
Your first step with investing in business buildings should include setting clear goals, such as understanding what your end game is well before you invest in your first property.
These goals should be written down in your real estate business plan.
Having a clearly defined mission will help you remain focused, even if you encounter difficulties during your investment process.
Understand Your Risk Threshold
What types of risks are you willing to take?
Do you have a large margin for error or are you more risk averse?
Before you begin making commercial investment moves, get a clear idea of your risk threshold. This will help you create the perfect investment strategy.
Investing in commercial property is a business venture. Like with any investment, be patient and do not get overly emotional about decisions related to your new undertaking.
Commercial investing is a marathon, not a sprint.
Be prepared to play the long game and stick to a winning strategy.
The Bottom Line: Commercial Real Estate Investing
Commercial real estate investing provides a spectrum of opportunities, not only from different property types but also from different investment formats.
Because there is no one size fits all answer for real estate and commercial real estate investing, the best way to get started is to educate yourself on the various pathways of options that interest you in order to minimize the risk and maximize the profit.