The real estate industry keeps growing with each passing year. Based on data-driven research by Statista, revenue in the US real estate sector is estimated to be USD$369 billion as of 2022. Also, it’s projected that there’ll be a 3.71% annual growth rate for the next three years.
The annual returns in commercial real estate are generally more compared to residential rentals. That’s because there’s more stable cash flow since lease terms are usually more solid and long-standing. Therefore, commercial real estate is an ideal option if you’re looking for long-term property investment. However, here are four things you need to know before getting started on this type of venture:
Commercial real estate investment options
As an investor, you can choose to invest in commercial real estate individually or seek partnerships. However, this requires a high initial investment cost and ongoing capital expenditure, which can be expensive if you’re on your own. Fortunately, you can consider real estate syndication, which entails pooling capital through investors with a common goal, as Moschetti Law describes.
The good thing is that real estate syndications can hire a syndication lawyer to help with legal documentation. They ensure everything is done according to the law.
Below are some advantages of real estate syndications:
- Passive investors can receive passive income distributions.
- You can invest in commercial properties without taking on the role of a landlord.
- Investors can select the type of properties they’d want to invest in
- You can diversify your portfolio by spreading capital across multiple syndications.
Also, note that you must meet specific financial requirements to be accredited for real estate syndication. Spouses should have annual earnings of at least USD$200,000 or USD$300,000. Investors with a net worth of USD$1,000,000 are also eligible.
The legal and regulatory aspects
Commercial real estate investments involve many legal and regulatory procedures. For example, you’ll be required to file all legal paperwork on property taxes, operating agreements, business insurance, and commercial leasing. All these can be complex and time-consuming to do on your own. Therefore, it’s best to have the support of an attorney who can guide you through all the legal formalities and documentation. They can properly explain clauses and uncover specific elements, such as hidden costs.
Also, note that there are additional government regulations regarding commercial properties. For instance, property owners must comply with the Americans with Disabilities Act (ADA) by ensuring their commercial properties are accessible to all. Landlords can accommodate people with physical limitations by providing wheelchair access or constructing railings.
Not all property types are the same
There’s a wide variety of real estate assets. Typically, commercial real estate has five categories: office, industrial, retail, special purpose, and multifamily. However, there’s still a vast pool that includes land, hotel, self-storage, and medical real estate. The demand, yield, supply, and profitability of each sector is different from the other.
Therefore, before you begin investing, find out the performance of each asset class in the current economy, establish the sector’s viability as an investment, and select the type of commercial real estate property you’d like to invest in.
Currently, the top-performing commercial real estate assets are industrial buildings, while retail space is the lowest. Retail spaces have been affected by the rise of ecommerce. So, consider crucial factors, like technological advancement, before settling on a property type.
Understand the market
Before investing in commercial real estate, it’s vital to have some insights into the market, including the current demand for various commercial properties. According to a survey on US commercial property, there’s a high demand in the industrial sector as of 2021. The vacancy rate was below 5% despite the economic implications of the pandemic. On the other hand, the retail sector was affected mainly due to the closure of businesses. For instance, the vacancy rate for the malls was slightly higher at 8.3%.
Luckily, the market has gradually recovered from the pandemic’s effects, promising for prospective real estate investors. Other market aspects to look into include:
Competition: Certainly, commercial real estate is an industry full of other established investors. Therefore, it’s best to determine how the neighboring properties perform and how you can have a competitive advantage.
Demographics: You’d want to focus on properties in growing and urban areas since they have a high occupancy rate. At the same time, avoid dangerous neighborhoods as they’re associated with low occupancy rates.
Also, due to market shifts, it helps to diversify your portfolio with different classes of assets to minimize the risks associated with one. For instance, you can invest in industrial buildings, offices, parking lots, retail stores, warehouses, movie theaters, apartments, or daycare centers.
Risks associated with commercial real estate investments
Just like any other type of investment, commercial real estate investments have their share of risks. Therefore, as an investor, it’s important to be aware of such events before acquisition to develop a risk management plan. Also, this enables you to evaluate the returns of investment (ROI) offered in light of all risk factors.
Below are some possible investment risks:
- Liquidity risks: Real estate properties are generally considered less liquid assets. That means it might take months before you manage to sell your property at the correct market price. And, if you’re to dispose of it immediately, you may have to settle for a price lower than its assessed value.
- Hidden costs: For instance, you may incur high costs of repairs due to underestimated structural problems.
- Problem tenants: This may result in delayed or unpaid rents and tenant credit risks, reducing the total returns.
- Leasing risks: High and prolonged vacancy rates mean there’s low-income potential. You may even have to deal with negative cash flows if there are high maintenance costs.
Knowing these risks beforehand helps you cushion yourself from monetary loss. Also, you can plan ahead and come up with strategies that’ll help avoid these risks.
How to find the right commercial real estate investment
Finding the right commercial real estate investment is a process with many factors to consider. You need to assess your financial goals and the risks you’re willing to take. With a clear idea of your investment strategy, begin looking at properties that meet your criteria.
When evaluating potential investments, you should consider the property condition, location, surrounding area, and age. Also, research the current and predicted trends of the real estate market.
With effort and time, you’ll become proficient and successful in commercial real estate investment.
Understand the market cycles
There are many things in the economy that directly correlate to the profitability of your commercial real estate. These could include the unemployment rate, population migration, economic health, and gross domestic product.
Hence, by understanding how the real estate market cycle works, you can avoid buying when the market is quite costly and selling when the market prices are low. Timing the real estate market cycle is crucial for achieving big returns on investment. You need to visualize the cycle to be able to grasp its predictability.
Knowing the specific indicators of the market cycles helps you determine opportunities that are present now, and you can make investment decisions based on current data.
Be prepared for extended timelines and setbacks
Most investors set unrealistic building, renovating, fully leasing, or reaching market rents timelines for their commercial real estate. But, you must understand that all these take time and could easily spill out of the set schedule. There’ll be obstacles and setbacks that’ll stall the progress of your investment. Hence, when doing your due diligence, you need to identify these obstacles and add them as part of your contingency costs or devise an action plan you can implement when delays happen.
If you’re investing through passive vehicles, like real estate syndication or crowdfunding, make your timelines and return expectations flexible. The performance of your real estate assets could rise or fluctuate after acquisition; thus, you should be well-informed of the risks and be conscious of them yourself.
Have contingency funds
As stated earlier, the risks you can encounter in real estate and the setbacks could result in unexpected expenses. Irrespective of the research, preparation, and verification you do, there’ll always be unknown factors that could negatively or positively affect your yield. To hedge this uncertainty, you need to plan for cost contingencies.
Cost contingencies are the extra funds you set aside to help with unexpected expenses. They’re helpful if there’s negative cash flow as you improve the overall property performance. Alternatively, you can use it to offset your debts as the property stabilizes and makes a profit.
Notably, the standard contingency budget in commercial real estate is 5%-15% of your capital. But, it usually depends on the asset performance and your season of acquisition.
Conclusion
As a prospective investor, knowing what to expect is vital before investing your hard-earned money in commercial properties. You must choose an investment strategy, understand all legal procedures, and know the market well and the risks involved. Most importantly, note that property investments are rewarding over the future; thus, it helps to be a patient investor. However, if your assets fail to appreciate, say, in the next five years, it’s best to consult an experienced financial advisor.
Born and raised amidst the hustle and bustle of the Big Apple, I’ve witnessed the city’s many exciting phases. When I’m not exploring the city or penning down my thoughts, you can find me sipping on a cup of coffee at my favorite local café, playing chess or planning my next trip. For the last twelve years, I’ve been living in South Williamsburg with my partner Berenike.