As I’ve tried to explain in my article “Commercial Real Estate Investing – Is this a Wise Move for You?“; commercial real estate refers to the properties that will be leased for commercial purposes, as opposed to those leased for living spaces. Commercial properties can be restaurants, office buildings, shops, work shops and more.
In order to invest in commercial real estate, you have to consider the investment from a legal standpoint. Any type of property, whether it is commercial or residential real estate, can be a good investment.
For the money, however, commercial real estate typically offers more financial incentives and rewards. These rewards come in the form of leasing income for renting a workspace. However, you also have to note the risks, especially in terms of liability. To know how to invest in commercial real estate, you have to look at the benefits.
Types of Commercial Properties
A commercial property, in and of itself, can refer to the following structures:
- Retail buildings
- Office buildings
- Industrial facilities
- Mixed use buildings, or buildings that combine retail and office space.
Naturally, nuances exist to managing any of these kinds of properties. However, for the most part, owning them offers the following benefits.
Commercial Property Investment Benefits
A Greater Income Opportunity
The best reason to invest in commercial real estate rentals is due to the earning potential. Commercial properties generally reap an annual return from the purchase price, between 6 and 12 percent, depending on the locale. You cannot get this type of return from residential real estate, which returns about one to four percent, at best.
Let me give you an example; with very rough estimation:
- If you purchase a residential property for 100.000 USD, you may expect between 1.000 – 4.000 USD as the annual rental income.
- If you purchase a commercial real estate for 100.000 USD, you may excpect between 6.000 – 12.000 USD as the annual rental income.
However, these are really rough estimations and there are always some exceptions. I’m just trying to give you an overall idea for the comparison between commercial and residentail real estate investments.
The Development of Professional Trust in Business Relationships
Small business owners who own commercial real estate are usually not considered individuals, but limited liability corporations, or LLCs. Therefore, when you invest in commercial properties, you must establish yourself as a business to be successful. As a result, the landlord and tenant also have more of a business-to-business relationship, which helps keep any interactions more professional.
How to Draw Up Your Blueprint to Invest in Commercial Real Estate
Knowing the above information can help you draw up an investment blue print- one that will assist you find a good commercial property deal.
Think Like a Professional Investor
To invest in commercial real estate, you have to realize that the property is valued quite differently. Commercial property income is associated with the square footage of the property.
You will also enjoy a greater cash flow with commercial properties. Commercial property leases also are longer than they are for single-family dwellings or apartments.
In addition, lenders for commercial properties require a larger down payment than lenders who loan money for residences. Expect to put at least 30% down on a commercial piece of real estate.
Map Out an Action Plan
You have to set parameters if you want to deal in the commercial real estate field. Here are the some basic questions that you should ask yourself while mapping out your action plan:
- Determine how much you can afford to pay.
- How much do you anticipate that you can make on a deal?
- Who are the major players?
- How many people are already leasing units in the building?
- How much rental space needs to be filled?
Putting down the answers for these questions will help you to decide your way forward.
Recognizing a Good Deal
The top commercial real estate professionals know when they spot a good deal. That is because they already have formed an exit strategy. You know the best deals are the ones you can easily walk away.
It also helps to have a keen eye – look for damages that need repairs, assess your overall risk, and calculate your financial objectives.
Know What Metrics to Employ
The common metrics to use when assessing a commercial real estate property include the following:
- Net operating income (NOI) represents a property’s gross operating income for the first year minus the annual operating costs. The NOI should be positive.
- The capitalization rate is employed for determining the value of income-producing properties. For instance, small strip malls or commercial office buildings can all be used for a cap rate calculation. The rates are used to project the net present value of cash flow or future profits. This process is known as capitalization of earnings.
- A cash-on-cash formula is used to contrast the first year’s performance of competitive properties. To uncover the formula, the investor determines the amount needed to invest to buy the property.
Seek Out Sellers who are Motivated
Like any business, customers are needed to drive real estate. Therefore, in the commercial real estate field, it is your goal to locate them. In fact, nothing really can take place in real estate unless you find a deal that includes a motivated seller.
A motivated seller always has a pressing reason to sell a property at a below-market value price. Look for motivated sellers as they are your keys that open the doors to real estate opportunities.
Evaluate Various Commercial Properties
An ideal way to assess a commercial property is to study the surroundings, or the community in which it is located. Also, stop by real estate open houses, look for vacancies, and talk to neighborhood business owners.
Learn to be Adaptable
When you are looking for commercial real estate, you need to learn to be adaptable. That is how you find great deals in the business. Make use of the Internet, hire “bird dogs” to locate properties, and scan the classified ads.
Real estate “bird dogs” locate valuable investment leads in return for a referral fee.
The Bottom Line of the Commercial Real Estate Business
Assessing and buying commercial real estate is not just about farming a neighborhood, receiving a special deal, or sending out certain smoke signals to attract sellers.
You also need, even more importantly, to build a good business rapport with real estate owners so they can discuss deals with you. Once you become acclimated to the business, you will know the importance of communications and building good relationships in this respect.
Real estate, like other investments, comes in various “flavors”. While most investors own residential properties and become landlords, the flashier real estate is made up of commercial properties.
Commercial real estate, unlike residential properties, are leased to supply a work area rather than a living space. In most instances, most of these properties are sold by the structure – one office building, one restaurant, one manufacturing plant, etc.
If a developer wants more capital in order to expand, or wants to see returns more quickly, the project is often separated into smaller units versus being sold as a whole.
A Healthy Cash Flow
One of the most attractive advantages of owning commercial properties is the attractive leasing rates. Look for properties in locations where new construction is limited, either legally or by the amount of land. In these areas, the real estate displays healthy returns, and considerable monthly cash flows.
That is because rental rates are typically calculated by square foot. The national average is about $22 per square foot for premium office spaces. Industrial buildings usually rent at lower rates. However, they have lower overhead costs as well.
Needless to say, those kinds of rates, give a commercial real estate owner, a considerable amount of stability with their cash flow, provided the building continues to be occupied by long-term tenants and is in relatively good condition.