Types of Commercial Real Estate Investments
Commercial real estate allows you to pool your money with other investors, diversify your portfolio, limit your losses, and have asset prices related to operating income.
Investors who want to go into commercial real estate but aren't sure where to start should first learn about the different types of investment instruments available.
There are many possibilities for both active and passive commercial real estate investors and considerable advantages over single-family home rentals.
Let's look at some of the options for commercial real estate investment.
Investing Directly
Purchasing or constructing a structure is the most straightforward way to invest in commercial real estate. Commercial real estate is always an intriguing possibility, whether you're a business owner who wants to own your building or an investor looking to improve your earning potential.
Direct investments are usually easier to appraise because income statements, rental rates, and other critical metrics are easy to get and analyze.
Direct commercial property investing offers considerable tax benefits, the flexibility to optimize occupancy and lease rates, and the potential to capitalize on market trends and selected locations based on personal preferences.
The disadvantage of direct investments is that they necessitate a high level of individual participation to ensure thorough due diligence, property acquisition, and continuing property management.
Furthermore, they necessitate a higher initial commitment, and the illiquidity of direct investments may force investors to retain a property for longer than expected.
Communal Tenants (TIC)
Tenants in common are real estate transactions in which a group of investors "pool" their money to buy a commercial property or property. Each investor in a TIC owns a percentage stake that is either equal to or proportional to their investment; This is a reasonably direct approach to engage in commercial real estate because each person receives their interest in the property, which may be resold without having to sell the whole thing.
While there is a measurable overlap between the two, crowdfunding is a type of TIC in which a group of investors pools their funds to buy a property. Crowdfunding has lower investment minimums, usually involves a sponsor and less active shareholders.
TICs allow you to invest directly in commercial real estate, but you are usually limited to only one building. Furthermore, there are very rigorous IRS rules, and the timing of the liquidation can provide some challenges.
Real Estate Investment Trust (REITs)
REITs are real estate investment trusts that buy real estate or stock in real estate companies. They combine money from investors to purchase commercial (and other) real estate properties.
Due to their corporate structure, they are compelled to share 90% of their earnings with investors. The majority of REITs are listed on a stock exchange and can be made up of real estate, mortgages, or a combination of the two.
Some REITs specialize in specific real estate categories, such as office, retail, industrial, or multifamily. Investors buy REIT shares, and the business then utilizes the money to purchase properties and distribute tenant cash flow to shareholders.
Publicly listed REITs provide investors with easy access to various real estate asset types and often pay out high-yielding dividends. The disadvantage of holding REITs is that management fees may be higher, and investors do not gain the direct benefits of real estate investing, such as depreciation.
Pros and Cons of Commercial Real Estate Investments
Commercial real estate can be purchased in various methods, both active and passive. The main contributors to your overall returns are liquidity and risk exposure.
Each sort of real estate investment has advantages and disadvantages, so consider all of them before deciding which is best for you and your portfolio.
In order to create a diversified portfolio and provide some protection against the volatility that may occur, including real estate is a good idea. Commercial real estate investing can give you significant return on your money, but it's vital to learn as much as you can about the property before making the decision to invest.
Here's a brief breakdown of how different property investments compare once you’re ready to start investing in commercial real estate.
1. Land Purchases
Investing in undeveloped land can be incredibly profitable for a well-informed investor with a clear understanding of the market. You can use raw land to create money in a variety of ways, depending on the type of land purchased.
For instance, if you purchase farmland, you can offer your acreage (or some portion of it) to local farmers. They can use it to cultivate crops or raise cattle or other livestock.
If you buy heavily wooded land, you could approach logging companies to discuss their interest in harvesting the timber. You can also purchase a piece of land, hold it for a while, and eventually sell it to a commercial real estate developer.
The first two examples offer a faster financial payback, but when you find a developer who’s the perfect fit, the third option can result in a hefty profit.
2. Office Complexes
The demand for office space across the country is high, in both large and small cities. If you live in a heavily populated metropolitan area, you may choose to purchase a high-rise building with dozens of office units. If you’re in a smaller town, you might choose a small medical practice building that only accommodates one or two tenants.
One big advantage of owning office space and renting it out is that tenants often sign multi-year leases, which makes it much easier to forecast future revenues.
3. Retail Areas
In terms of profit potential, retail space investment is similar to office space. The biggest difference is location, which is a crucial factor to consider before you invest in any retail space.
Let’s say you’re considering the purchase of a strip mall with 15 units. The question you need answered is whether there's a consistent, steady flow of traffic in the area. Tenants may feel forced to leave due to a lack of business. This can leave you with empty units, which can decimate your profits.
4. Self-Storage Units
Although storage units may not be the first thing to come to mind when discussing commercial real estate, you can definitely make money with this type of commercial real estate investment.
You also don't need to live in a big city to benefit from investing in self-storage facilities.
These days, towns of every size have many self-storage options available. Things to consider before investing include location as well as local competition, and both are critical elements in forecasting profitability.
5. Multi-Family Housing Units
Multifamily housing typically refers to apartments or condominiums, although sometimes you’ll hear the phrase used when referring to townhouses, duplexes, triplexes and quadplexes. Although these are residential rentals, they’re still included as commercial real estate.
Multifamily housing is typically more expensive to invest in and maintain, it offers the potential for consistent, often long-term rental income.
Because of the increase in rental rates and a growing demand for apartments, investment in an apartment complex can provide investors with a steady source of income.
6. Industrial Property
Examples of industrial properties include manufacturing and research facilities, warehouses and distribution centers, just to name a few. With this category of commercial real estate, it’s harder to predict demand for these types of properties, so you’ll definitely want some professional guidance with this investment strategy.
Investing in Commercial Real Estate: What to Look for
Investing in almost anything typically comes with its own set of potential risks and benefits, and commercial real estate is no different. Here are a few questions you should ask when comparing potential investment properties:
· How much revenue do you anticipate the property to provide?
· How long are you planning to hold the property?
· What is the current market value for this sort of real estate?
· How much risk factor is involved and what level of risk are you willing to take?
The better your research before the investment, the better your success as a commercial real estate investor.
Before You Invest
Consider the benefits of working with a great CRE brokerage firm. It makes commercial real estate investing an exciting - rather than a daunting - process. At Maddox Companies in Knoxville, TN, we work hard for our clients so they experience success in the commercial real estate market. Check out our portfolio to learn more about what we’ve done for others - and what we can do for you.