Commercial Real Estate Investing 101: How To Start In 2021
Commercial real estate has long been the preferred avenue of the wealthy and elite to invest, and it’s not so hard to see why. Commercial real estate investing is a viable solution to diversification of assets, offers clear advantages to residential real estate, and historically yields higher returns. But “the rich get richer” no longer applies to this industry, as the high barrier of entry has been removed and now investing in commercial real estate is for everyone.
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What is Commercial Real Estate Investing?
Any place that you frequent in your daily life is operating out of a commercial property: your office, your neighborhood grocery store, your favorite clothing boutique or mall, and if you live in a high-rise apartment complex, this is a commercial property, as well. Simply stated, commercial real estate is property that is used exclusively for business-related purposes. Some business owners own the building they occupy; however, it is more common that the commercial property is owned by an investor or group of investors, that lease the property to business owners, so they can operate their store front. Just like residential properties, the business owners are the tenants. The rental price is quoted in annual dollars per square foot, and it is the rent that generates returns for the commercial real estate investors. Unlike residential rental properties, however, commercial leases typically run from at least 3 years, and more commonly 10 years, or more.
Benefits of Investing in Commercial Real Estate
Why invest in commercial real estate? Commercial real estate investments offer a secure and scalable approach to real estate investing, especially when you look at commercial vs. residential. Here’s why:
As previously mentioned, commercial real estate offers long term leases (3-10+ years). This means guaranteed cashflow for a long period of time, and less work as a result of not having to find a new tenant or renegotiate a renewal each year. Of course with this long-term commitment you run the risk of being stuck with a bad tenant; however, if you do your due diligence and thoroughly vet incoming tenant’s financials and background then your reap the rewards for years to come.
Unlike residential properties, in which the value is largely determined by what comparable properties are sold for, commercial property’s value is based on the revenue it generates: the higher the revenue generated through rent, the higher the value of the commercial property. In this respect, the appreciation of your asset is more in your control. By finding the right tenants and drawing-up fair, but profitable leases, you can force the appreciation of your investment property.
High Quality Tenants
As opposed to renting to individuals, when you invest in commercial real estate, you are renting to businesses. This offers a security net, as these leases will usually be backed by the company with a personal guaranty from the partner or partners in the business. Beyond the financial security of a business, is the likelihood that the commercial real estate tenant will treat the property with more care than an individual tenant in a residential property, as this is their brick and mortar–the appearance of the space is directly tied to image of their brand and business.
Moreover, vetting these tenants to ensure they are, in fact, high quality is easier than vetting tenants for a residential property, as commercial real estate is not regulated by the Fair Housing Act. As a commercial real estate investor, you can ask your prospective tenant for just about anything during the vetting process and can refuse to lease to them without the concern of legal repercussions.
When asking yourself, “Is commercial real estate a good investment?”, think about the immense advantage that your tenants have skin in the game in terms of maintaining your asset. As well as the fact you can go to whatever means necessary to ensure they are high quality.
Steady Cash Flow
Commercial real estate cash flow is traditionally dependable (because of your high quality tenants), consistent (due to your long leases), and profitable.
Why is it so profitable? Well to start, there are fewer expenses associated with operating the property, as commercial tenants typically assume expenses like property taxes, insurance and building maintenance.
This is called a triple net lease (NNN). Why would a business agree to do this? For larger corporations this is preferred, so that they can maintain their brick and mortar locations’ look and feel without relying on the landlord.
Types of Commercial Real Estate Investments
Looking to understand how to invest in commercial property? Start with picking a type. Commercial real estate investment can be broken down into 5 categories. The 5 categories are then broken down into subclasses: A, B and C.
Any of the below categories that would fall under Class A means this property is amongst the cream of the crop. Whether it’s an office building, retail space or condo, Class A CRE is usually newly constructed, and if old, is well maintained. Class A comes with extensive amenities: In the case of an office building, there would be onsite management and security and in the case of a condo, state of the art pool(s), gym and spa. They are also likely in a prime location and have premier tenants.
Class B CRE, in many cases were once Class A, but they are past their prime and not pristinely maintained. They are probably not as centrally located. However, what the commercial property investment sacrifices in amenities, it makes up in price.
Lastly, Class C CRE are your functional properties–no bells and whistles, but they serve their purpose and are definitely deals! As long as you are ok with a slow elevator and not so lux finishes.
Now that you know the classes lets get into the types…
Commercial real estate investors are drawn to office spaces, as they are multi-tenancy properties. Your best bet is investing in office space that is located in the central business district–characterized by high-density of mid to high-rise buildings that house many different offices. Higher quality tenants will tend to locate within these buildings due to the convenience and walkability factor. Whether it be offices or any other commercial property investment real estate its all about location, location and location!
Retail commercial real estate, refers to any property that houses a business that sells products and services directly to consumers. This commercial real estate investment can range from a standalone restaurant, to a neighborhood strip mall, to a massive shopping center.
Industrial commercial real estate has boomed in recent years due to the rise in demand for delivery. This type varies the most in purpose and size. Industrial commercial real estate includes warehouses, storage, manufacturing, as well as assembly. The major benefit being, these tenants often sign long leases and renew these long leases, as there are few reasons to relocate. While perhaps not as sexy as retail or office, Industrial CRE is a solid investment.
Multifamily commercial real estate is residential property with more than one unit, including everything from duplexes to massive condo complexes. This commercial real estate investment offers ample opportunity for residential real estate investors to dip their toes in the waters of the commercial world. Having multiple tenants allows you to mitigate risk with multiple streams of revenue.
Special purpose commercial real estate investment is a property that is appropriate for one use or limited use, as the building cannot be converted to another use without a large capital investment. This can be anything from amusement parks, gas stations, hospitals, museums, theaters, wineries or swimming pools–to name a few!
How to Invest in Commercial Real Estate
There are several avenues in which you can start investing in commercial real estate. These different avenues vary in barrier of entry, as well as potential returns, but all are making money in commercial real estate.
Crowdfunding (best way to get started in CRE)
The best way to get started in commercial real estate investing is through commercial real estate crowdfunding. Previously commercial real estate was limited to accredited investors (i.e. heavy hitters who make at least 200K annually or have 1 million in assets). But now anyone can start making money in commercial real estate with as little as $500. Crowdfunding has such a low barrier of entry, as it is a mutually beneficial method where private companies seek out many small individual investors to pool their funds to deploy to large scale projects. Moreover, you are able to grow your capital and generate passive income without assuming the responsibility of owning commercial real estate and being a landlord, or paying high fees associated with REITs. Crowdfunding makes it possible to invest like the financial whales, and you can too through School of Whales.
Construction and Development
Not into commercial real estate income funds? Starting in commercial real estate through the construction and development avenue is not for the faint of heart and is most likely associated with a steep learning curve. This approach is for the commercial real estate investors who are not willing to stand on the side lines.
In beginning such endeavor you should first pick your real estate type: Office, multifamily, retail, industrial. Then, you decide your scope: Do you want to build from the ground up or remodel an existing building. School of Whales, for example, invests in projects that take existing historic buildings and repurposes them. So to preserve the beauty and cultural significance of the original architecture, but make useful in modern day. These are called Value Add properties, and while they may require a little more elbow grease, they also offer potential for very high returns.
After picking our type and scope, you need to consider size. Go big or go home does not apply in this scenario. In fact, if you are a green developer, you should start with projects on a smaller scale.
Lastly, know your risk tolerance. Anyone embarking on this endeavour should understand that this is an illiquid and long-term investment. If you want to mitigate risk, your best bet is going with a horizontal development. If you buy a strip mall and renovate several units, you can lease those out as you finish the others; whereas, a vertical development like a 10 floor apartment building, can very rarely be leased out in phases. So, you are not getting a cent back on your commercial investment real estate until the project is 100% complete.
An Exchange Traded Fund (ETF) is traded on stock exchanges such as NYSE and NASDAQ; however, unlike stocks where you are purchasing a piece of one company, with ETFs you are purchasing a basket of securities offered by public companies, and in this case, public real estate companies–the advantage being the ability to invest in the industry without having to cherrypick the companies. Given that these commercial real estate investment funds are passively managed–buyers and sellers are doing business with one another, so managers have far less to do–ETFs are associated with lower expenses, than say Mutual Funds.
The price, like stocks is based on the trades within that day. Unlike stocks, however, ETF providers can manipulate the price in order to ensure it aligns as close as possible to the net asset value of the index. How do they do this? Supply and demand, of course! Price too high? ETF providers will create more shares.
Real estate mutual funds are professionally managed commercial real estate funds that invest in REITs, publicly traded real estate operating companies and bonds. Real estate mutual funds have the advantage of diversification, as you are investing in a broader selection of real estate assets. Moreover, as a real estate mutual fund investor, you have access to analytical insights and research from your portfolio manager. Mutual funds performance is largely tied to REITs performance (given they hold these within the portfolio); however, can be less tax-favorables and carry higher management fees.
Real estate investment trust (REIT)
A REIT, which stands for real estate investment trust, is a corporation that owns and/or manages income-producing commercial real estate. They have been around since the 1960s, and there are many types of REITs. Most will focus on a specific commercial real estate investment type: retail, hospitality, multifamily housing, senior living facilities, student housing, office, self-storage and industrial. By law, REITs are required to return 90% of profits to investors in the form of dividends i.e. passive income.
When an individual investor buys a REIT share, they are purchasing a share of the company that owns and manages the rental property. He or she is not investing in an actual property or properties. In this respect, it is similar to investing in the stock market, and its performance is closely correlated to the stock market.
Real Estate Investment Groups
You know the saying “strength in numbers.”–Well that’s the fundamental objective of starting or joining commercial real estate investment groups (REIGs). A real estate investment group is a legal entity formed by a group of private investors who invest in real estate by pooling money, knowledge and time to purchase properties that generate income.
Commercial real estate syndication and crowdfunding are terms that are often used interchangeably; however, they are not synonymous: Commercial real estate syndication is a temporary alliance of individual investors or businesses that pool their funds to invest and manage a large project that would be difficult or impossible to fund and manage individually. Crowdfunding is one method of facilitating the syndication i.e. finding the investors. Crowdfunding just makes syndicates accessible to more people. In a syndication, the group of equity investors will from an LLC where finances and project structure can be managed. There may be multiple LLCs within the master LLC.
Commercial real estate investing 101: tips for beginners
Know your Numbers: Evaluate your commercial real estate opportunities using industry metrics
Investing in commercial real estate for beginners can feel overwhelming, but knowing what metrics to use when evaluating potential opportunities can help simplify things.
- Cap rate: Cap rates are calculated by dividing a property’s net operating income by the current market value. Don’t know what those are, well you’re in luck…
- Net Operating Income: To calculate NOI, subtract all operating expenses (these are expenses incurred from conducting normal business except for interest expenses and income taxes, as well as capital expenses like money invested to improve the property) from all revenue generated from the property. NOI will indicate to a property owner if renting a property is worth the expense of owning and maintaining it.
- Current Market Value: an opinion of what a property would sell for based on current market conditions. Remember for CRE this is largely determined by the revenue generated from renting the property.
- Management Fees: Before committing to any investment, you should understand the fees associated with holding this investment. REITs and mutual funds can charge anywhere from .05% to 5% of holdings to manage your money.
Understand where your money is going: Pick CRE investment opportunities according to type and scope
Whether you are investing via a crowdfunding, mutual funds, REITs or syndication the type of CRE in which the entity is investing should be taken into consideration. Is the REIT in which I am looking to invest focus on multi-family living or office space or both? Are these large scale projects or boutique projects? You should be fully informed, and make the decision on where you are putting your money based on the metrics mentioned above, as well as market trends…
Do your commercial real estate due diligence: Understand market trends
Know the market trends when you invest in commercial property. Beginner CRE investors, you should be up to date with the news, read about past commercial real estate projects and investors, and listen to podcasts and panels from experts. You do not need to be a seasoned industry expert to invest in the market, but you do need to listen to them. Through this you be on the cusp of current industry trends and understand where the market is predicted to go.
Know how to ask for help
Which leads us to our next point–know when to ask for help! Recognise that you are the person surrounded by trees, and a mentor is seated outside the forest. He or she has been through the trials and tribulations you may be experiencing already. Maybe you already have a seasoned person within your network or maybe you need to join an REIG to build a rapport with a more experienced investor, either way having someone to save you from yourself is sometimes the best tool to deploy in reaching success.
Remember a patient investor will likely be rewarded. Successful investing requires time, and commercial real estate in particular is about the long game. Whether you are directly involved in the constriction and development or a silent investor via a syndication, the land must be purchased, developed and then rented our or sold in order for the investors to see returns. Your timeline can be anywhere from 3-5+ years.
Smart investing is not necessarily about earning the highest returns. High returns typically imply volatility and tend to be one-time hits that are very unlikely to be repeated. It’s about earning pretty good returns for a long period of time, so that you can then use these returns to reinvest and continue to build your wealth.
Investing in commercial real estate: Our Key takeaways
Real estate is a sound long-term investment compared to other investing opportunities, and there are many avenues to take in order to get involved. But beyond the intrinsic value of this finite resource of land, there is a sense of being a contributor to the community in which you live. Imagine dining in Miami’s newest trending spot, relishing in the impeccable ambiance and exquisite food and drink, while knowing that you made this project possible—and best of all, you are making money off of it!
Still got questions? We have answers! Getting started investing in commercial real estate for beginners can be overwhelming, so below we break it down.
How do I get started in commercial real estate investing with little money?
Still wondering how to start investing in commercial real estate? In case you’re a skimmer and missed our previously shpeal. The best way to begin investing in commercial real estate is via crowdfunding.–Why? Because of the remarkably low barrier of entry and low fees associated with the investment. In the case of School of Whales, you only need $500. Of course, this low barrier of entry also means lower returns. 10.5% of $500 will only get you so far. Which is why we created recurring investments. You can set-up a monthly recurring investment for as low as $10, that would go towards your original investment. So you can maximize your investment, without compromising your lifestyle.
What is a good ROI on commercial real estate?
When investing in a commercial property, typical annual yields will be anywhere from 6%-12%. So, anything 8% or higher is considers a good return. Commercial real estate investments offer clear advantages to residential real estate and historically beat the stock market in returns. Now you know how to get started in commercial real estate investing and start making money in commercial real estate.