Real estate investment is one of the many ways through which investors yield higher investment returns. This type of investment is typically divided into residential and commercial real estate. In this article, we shall be focusing only on the latter. So, what is commercial investment real estate?
What Is Commercial Investment Real Estate?
Commercial real estate investing involves the purchase or development of properties designed to accommodate a business or a workspace. Instead of renting their properties for residential purposes, commercial real estate investors lease out and collect rent from businesses that occupy their property. This definition also includes raw land purchased for commercial development.
Commercial real estate is usually more lucrative than residential real estate. This is because commercial properties usually have longer leases and lower operational costs that should be paid by the property owner relative to residential real estate.
Types of Commercial Real Estate
Commercial real estate differs based on property type, the intended use of the property, and property class. Here are the main types of commercial real estate:
These are properties that are flexible and technologically advanced to provide ideal working settings that are safe and accessible for official and business uses.
Office buildings are typically classified into:
- Class A: They are considered premium properties in terms of age, appearance, and quality, and they are situated in choice areas. They also have a definite market presence
- Class B: They are slightly less when compared to Class A. They may be of good quality but they normally older and may or may not be located in very competitive areas
- Class C: This is the lowest classification. These buildings are very old and most require thorough renovation. These buildings are typically situated in less desirable areas and they have low rental rates
These are commercial properties or buildings tailored to provide and market goods and services to the consumers. These buildings include:
- Shopping malls and centers
- Big box retailers
- Factory outlets
- Power centers
- Retail warehouses and parks.
These are simply commercial buildings that are tailored to provide healthcare to consumers. These buildings include:
- Medical centers
- Blood banks
- Nursing homes
- Psychiatric homes.
These are large properties generally used for industrial operations such as manufacturing, power production, and mining of raw materials. These properties are commonly situated outside urban and residential areas, especially along important routes of transportation.
Examples of industrial buildings include
- Heavy industrial buildings
- Buildings containing both industrial and office space known as flex warehouses
- Cold storage buildings.
Leisure facilities are large commercial buildings solely for carrying out leisure activities. Examples of such facilities include:
- Sports facilities
- Swimming pools
Difference Between Commercial and Residential Real Estate Investment
There are three main types of real estate properties or assets – commercial properties, residential properties, and land. While commercial real estate investment deals with properties that have five or more units and are used strictly for business purposes, residential real estate deals with single-family homes or one to four-unit properties used strictly for residential purposes.
Land investments, on the other hand, entail purchasing raw, undeveloped lands with the intention of development. Such developments include:
- Residential development
- Commercial development
- Farming and
Metrics to Consider When Investing in Commercial Real Estate
Commercial real estate investment usually yields a good return of about 5% to 12% annually. However, this yield can be majorly influenced by a number of factors. It is important for investors to put these factors into consideration to ensure good yields on their commercial properties.
Location of the Property
The location of a property plays a vital role in determining its market value, and as a result, is one of the most important factors to consider when purchasing a commercial real estate property.
An area’s proximity to major cities, basic amenities and recreational centers, its potential for development, and its safety profile are all factors that determine whether tenants would be willing to take properties located in the area, and what amount they will be willing to pay.
Reports of Due Diligence
Due diligence refers to a thorough analysis of a property to be acquired carried out by a buyer in a bid to ensure that there are no physical or legal encumbrances that could turn out to reduce the property’s yield or its worth in general.
These investigations include:
- conducting property inspections and feasibility studies
- reviewing documents related to the property such as leases, appraisals, tax returns, tenant rent roll, profit and loss statements from the previous owner, environmental reports
- Title search to identify liens, encumbrances, and disputes on the property.
State of the Local Market
Although commercial real estate is not significantly affected by market changes as most of the other common investment options, these changes do affect the rate of rentals and vacancy as well as the stability of occupancy.
Therefore, before acquiring a commercial property, it is important to pay attention to other comparable properties within the area.
Hiring a Professional Agent
There is no rule that states that an investor must hire an agent; however, involving experts in the process of purchasing a commercial asset is highly advisable.
A proficient and experienced agency like Si Vales Valeo Real Estate would leverage its years of knowledge and experience in the Cincinnati-Northern Kentucky market to guide you in choosing the right commercial property for investment.
They assist you throughout the process of acquiring the property including negotiations, and contracts, as well as carrying out due diligence. They also help make informed decisions to avoid costly mistakes that could incur losses on the part of the investor.
Methods of Investing in Commercial Real Estate
People invest in real estate for various reasons. While some people see it as a means of achieving long-term financial freedom, others simply use it as a reliable means of constant cash flow. Whatever your reasons are, here are some other ways you can invest in commercial real estate without buying a property:
Real Estate Investment Trusts (REITs)
Investing with public companies that solely own, manage or finance income-generating assets such as apartment complexes, warehouses, hotels, etc, is one of the popular methods of generating revenue.
This is due to the potential for high revenue yield and liquidity. Investors buy shares or stocks in the property, and then the company leases out these properties to tenants. The income generated with REITs is then distributed as dividends to the investors.
This is the most common and direct method of investing in commercial real estate. Some investors prefer a more hands-on-deck approach to commercial real estate investments so they purchase these properties upfront and rent them out to suitable tenants.
This method provides a steady income and allows the investor to maximize leverage to make even more profits.
Property flipping is another method investors employ in maximizing commercial real estate. Some investors acquire properties and quickly sell them at a profit. However, flipping requires extensive knowledge of the market and expertise to identify assets with high yield potential.
Real Estate Investment Groups (REIGs)
Real Estate Investment Groups are quite similar to REITs however, these are partnerships and groups of individuals. They share similar financial goals and come together to pool their funds in order to finance projects and investments as well as make investment choices together.
The properties are owned by a single investor, however, but the group is actively involved in the management of all the units including handling maintenance, and vacancy advertisement. In addition to the steady income flow, this method provides adequate financing as well as a safety net for investors.
Online Real Estate Investing Platforms
Another good method of maximizing the commercial Real estate market is crowdfunding. For one reason or the other, developers may not be able to fully fund projects or investments. Hence, this is where other investors come in with their funds to help finance the project.
This method of investment gives investors access to a wide variety of properties at a lesser cost when compared to other methods of investing. Some of these platforms include Fundrise and RealtyMogul among others.
How to Evaluate Commercial Property
As a potential investor looking to make profits through commercial real estate investment, it is important to properly appraise the economic value as well as the potential revenue of a property before investing. Some methods employed in evaluating a property’s potential value include
Value per Gross Rent Multiplier
This evaluation formula is an easy way to appraise a property’s potential yield after investment. The property’s current price is divided by the gross rental income generated. Hence, it is vital to know the current gross rent multiplier for other comparable properties within the area.
However, this method does not consider expenses like repairs, maintenance, or losses suffered. The value is obtained using the formula: Property Value = Yearly Gross Rents x Gross Rent Multiplier, where the Gross Rent Multiplier is a value greater than one.
Using the cost approach method of evaluation, a property’s potential profit is obtained by calculating the current price of the land on which the property is built and all expenses spent to build the property in question.
Therefore, the formula for calculating is: Property Value= Current Land Price + Cost of Construction
Sales Comparison Approach
The market approach technique utilizes the current prices of comparable properties in the area that were recently sold. It also takes into consideration the current asking prices of recently listed similar properties.
Hence, the value is determined by using the formula: Property Value = Net Operating Income (NOI) / Market Rate.
Income Capitalization Approach
With this method, the income generated through rent is the major determinant of the property’s value. The investor calculates the estimated overall income to be generated by the property based on the rent and the potential resale value of the property.
Is Commercial Property a Good Investment?
Yes, commercial property is a good investment. Real estate investment regardless of the type, has proven over time to be a profitable investment opportunity. Commercial real estate investment provides investors with the opportunity to earn incomes steadily, even when the market is unsteady.
It also allows property owners to accumulate equity faster due to the potential for these properties to gain value as time passes.
Commercial real estate investment is one of the major ways by which property owners make profits in the real estate business. However, to maximize the market, investors need to carry out the due diligence required. Finally, consulting with professionals is another aspect whose importance cannot be overstated.