Why Invest In Commercial Real Estate

Why Invest In Commercial Real Estate

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Introduction

Why invest in commercial real estate? Here are 13 reasons.

As a substitute for stocks and bonds, many investors look for real estate investment opportunities.

Even in uncertain economic times, commercial real estate in particular has the potential to provide the capital growth and consistent returns that most investors seek.

Here are 13 reasons you might want to think about adding commercial real estate to your portfolio, regardless of whether you’re thinking about investing in an apartment building, office space, light industrial space, or a self-storage facility.

What Is A Commercial Real Estate?

Commercial real estate (CRE) refers to real estate that is used solely for business-related purposes or to house a workspace, as opposed to residential real estate, which is used for living purposes.

The majority of the time, tenants lease commercial property to conduct businesses that generate income. From a small retail space to a sizable shopping mall, this broad category of real estate can include anything.

Different types of commercial real estate exist. Any structure, including an office complex, a duplex, a restaurant, or even a warehouse, may qualify. Commercial real estate can be leased out or held and sold again to generate income for people, businesses, and corporate interests.

Retailers of all kinds, hotels and resorts, office space, strip malls, healthcare facilities, and restaurants are just a few examples of the various types of commercial real estate.

The two main types of real estate property are commercial real estate and residential real estate. Residential properties are those set aside for habitation by people rather than for commercial or industrial use.

Commercial real estate, as the name suggests, is used in business, and multi-unit rental properties that are homes for tenants are regarded as the landlord’s commercial activity.

Likewise, there are various subtypes of office space. Class A, Class B, or Class C are frequent designations for it:

Aesthetics, age, infrastructure quality, and location all combine to make Class A buildings the best.

• Class A buildings are the best in terms of appearance, age, infrastructure standard, and location.
• Class B structures are typically more aged and less price competitive than class A structures. Investors frequently choose to restore these structures.
• Class C structures are the oldest buildings, which are typically older than 20 years, located in less desirable areas, and require maintenance.

Even though some zoning and licensing authorities further categorize industrial properties—locations used for the production and manufacture of goods, particularly heavy goods—most authorities view them as a subset of commercial real estate.

What distinguishes commercial from residential real estate?

Private living accommodations are the only use for residential real estate. Any property used for commercial purposes is referred to as commercial real estate. Hospitals, manufacturing facilities, storage facilities, retail establishments, office buildings, and other business establishment locations are examples of commercial real estate.

Is investing in commercial real estate a wise decision?

It certainly is possible. Commercial real estate can produce impressive returns and sizable monthly cash flows, and returns held up well during the market shocks of the previous ten years. Commercial real estate does, however, carry risks, just like any investment.

Types Of Commercial Real Estate

According to its purpose, commercial real estate can be divided into four categories:

• Office space
• Retail
• Industrial use
• Multifamily rental
• Hotel

Further categorization of specific categories is also possible. For example, there are numerous varieties of retail real estate:

• Restaurants
• Strip malls
• Healthcare facilities

1. Office

Urban and suburban office buildings can generally be divided into two categories. Skyscrapers and other high-rise structures that are used as urban office buildings can be found in cities; some of them have a size of up to a few million square feet. Office buildings in suburbs are frequently smaller and arranged in office parks.

Office buildings can have multiple tenants or just one, and many of them are custom-built. Class A, Class B, and Class C are the three classifications that they fall under. According to the Building Owners and Managers Association International (BOMA):

Class A Office

Most prestigious buildings, with rents higher than average for the area, competing for top office users. Buildings have modern systems, excellent accessibility, and a distinct market presence. They also have high-quality standard finishes.

Class B Office

buildings with rents that are typical for the neighborhood and competing for a diverse range of users. For the area, building finishes range from decent to excellent.

Systems are adequate, and building finishes are average to good for the neighborhood, but at the same price, the building cannot compete with Class A properties.

Class C Office

buildings in the market to lease space to tenants who need it at rents below the neighborhood average. One specialized subsector in this market is medical office buildings.

2. Retail

The term “retail” refers to the buildings that house the shops and eateries we frequently visit. They can be multi-tenant buildings (often with an anchor, or lead tenant, who helps draw traffic to the property), or single-use, standalone structures.

The retail industry is challenging because there are many factors that determine the type of shopping center, such as size, concept, types, and quantity of tenants, as well as trade area.

3. Industrial

The majority of industrial buildings are found outside of urban areas, particularly along important transportation corridors, where they house industrial operations for a variety of tenants. Industrial parks can also be created out of low-rise structures. Four types of properties are distinguished:

• Heavy manufacturing: The machinery that manufacturers need to operate and produce goods and services is housed in these highly customized buildings.
• Light assembly: These can be used for product assembly or storage because they aren’t as customized.
• Bulk warehouses: These are typically sizable properties that serve as distribution hubs.
• Flex industrial properties: These have a combination of commercial and industrial space.

Facilities for research and development (R&D) are a particular category of industrial.

4. Multifamily

All residential real estate types besides single-family homes are included in the multifamily sector, including condos, co-ops, apartments, and townhomes. Multifamily properties are frequently divided into Class A, Class B, and Class C, just like office buildings.

Particularly, apartment rental buildings are divided into various property types. They have been divided up by Freddie Mac into six different categories:

• High-rise: An establishment with at least one elevator and nine floors or more.
• Mid-rise: An elevator-equipped multistory building that is usually found in a city.
• Manufactured Housing Community: A community where the manager rents out building lots to owners of mobile homes.
• Garden-style: A suburban, rural, or urban one-, two-, or three-story apartment building constructed in a garden-like setting; buildings may or may not have elevators.
• Walk-up: A four to six-story structure devoid of an elevator.
• Housing For Specific Purposes: A piece of multifamily real estate, regardless of style, that caters to a specific demographic, such as senior housing, student housing, or housing for people with special needs.

5. Hotel

The hotel industry includes businesses that offer lodging, meals, and other services to tourists and travellers.

Hotels can be independently owned (boutique) or flagged, which means they are a part of a well-known hotel chain like Marriott or Sheraton. They are divided up into six different categories by Real Capital Analytics:

• Limited Service: No concierge, on-site restaurant, or room service.
• Full-service: Has an on-site restaurant and offers room service.
• Boutique: Has fewer rooms, is not a part of a large national chain, is situated in an urban or resort area, and offers full-service amenities.
• Casino: Contains gaming elements, such as video poker or slot machines.
• Extended stay: Larger rooms for extended stays and limited service with fully furnished kitchens in the guest rooms.
• Resort: Large, full-service resort with a golf course, water park, or amusement park attached that is situated in a typical resort destination (like Hawaii or Orlando).

Why Invest In Commercial Real Estate

1. Investment In Commercial Property Ensures Consistent Cash Flow

Why invest in commercial real estate? Because a strong and reliable cash flow can be offered by commercial real estate.

Commercial real estate investments are set up to pay investors regular dividends every month, quarter, or year, just like stock distributions do. The return is usually higher than stock distributions, though.

In both public and private markets, commercial real estate consistently outperforms the S&P 500 over longer time frames—up to two times. For instance, while stock investments can yield an annual compound return of 8 to 9%, real estate investments can generate up to 15% in cash flow.

With commercial real estate, investors benefit from more favorable tax treatment on those returns in addition to higher cash flow.

For investors, they have two choices:

Equity Investment

Investing in equity entails acquiring a small stake in a tangible asset, such as an apartment complex or office building. Rising rents give investors the reliable cash flow they want.

Debt Investment

This involves making a real estate loan investment using a building or piece of land as collateral. The fact that this type of investment is typically designed to provide a fixed return is one of its most alluring features.

2. Commercial Real Estate Ensures Capital Preservation

Office buildings are real assets with observable, palpable value. This value is primarily influenced by the building’s quality, its location, and the existing tenants’ credit, all of which are stable variables.

On the other hand, a number of macroeconomic and microeconomic factors can cause significant overnight changes in the value of shares of a publicly traded company.

For those whose main priority is capital preservation, investing in real assets is a much safer option due to this potential for volatility.

3. Adding Commercial Real Estate To Your Portfolio Diversifies Your Asset

Diversification is crucial to the success of any astute investor’s portfolio. Traditional investments, however, such as stocks, bonds, mutual funds, and EFTs, aren’t sufficiently diverse to guarantee steady returns during a market downturn.

Diversification offers protection from losses. Investors may still earn returns from investments in other classes if one underperforms. Any truly diverse portfolio ought to include commercial real estate.

The stock market and commercial real estate have little in common. Commercial real estate investment might not be impacted by a decline in the stock market. Volatility in one does not always translate into anything at all in the other.

More differentiation is possible within commercial real estate. There are various types of commercial real estate, and investing more broadly in commercial real estate can further diversify a portfolio.

4. You Can Accumulate A Lot Of Equity Through Commercial Real Estate

Why invest in commercial real estate? Because you can get a lot of equity. Equity is the value that an investor has accumulated over time.

With the steady and comparatively high returns that commercial properties produce, the investor can quickly build equity with commercial real estate. In addition, they stand to gain significantly as the value of the property rises.

5. Commercial Real Estate Is Valuable As A Tangible Asset

A tangible or hard asset is real estate. Real estate always has intrinsic value due to the building and the land, unlike stocks, which can be valuable one day and not valuable the next. The price of the property reflects the possibility of producing other goods or services using this tangible asset.

This tangible asset won’t change, regardless of how much property values change. The investment will continue to have value.

Even though rents may or may not be paid, occupancy may change, and in the case of dishonest managers, there may even be a foreclosure, the value of the property will never decrease to zero. There is the potential for profit as long as there is land. The financial commitment is never worthless.

To create new value opportunities, the hard asset can be reorganized or modified.

6. The Appreciation Value Of Commercial Real Estate Is Excellent

It is historical fact that, in comparison to other asset classes, commercial properties have consistently provided excellent appreciation value. The asset’s marketability can be raised through proactive management and cost-effective improvements.

7. Commercial Real Estate Has A Lot Of Tax Benefits

Why invest in commercial real estate? Because you can get a lot of tax benefits.

Owning commercial real estate has tax benefits. The investor must set aside a portion of their income when buying stocks and bonds to cover capital gains taxes.

These taxes must be paid unless the investment is a component of their retirement account or a “qualified” plan. Capital gains, however, might be minimized or even avoided with commercial real estate.

If the investor has real estate in a desirable area, its value should rise over time. The investor may, however, take deductions that lower their taxable income (depreciation).

Through a 1031 tax-deferred exchange, the investor can completely delay the profits after selling a property. If they invest in a comparable property within a certain time frame, they may use this 1031 exchange.

8. Investing In Commercial Real Estate Is Safe

Real estate with a strong intrinsic value is classified as commercial property. A commercial property qualifies as a hard asset because both the land and the building have value.

Even when they don’t have tenants occupying their properties, investors will be protected from cash flow loss by purchasing commercial real estate in the ideal location. So, the safest and most secure kind of real estate investment is in commercial property.

9. Commercial Real Estate Is An Inflation Hedge

Investing in commercial property protects against inflation. Landowners may raise the rent they charge as the economy expands and prices for goods and services rise. People can afford to pay more for rent as a result of increased income thanks to economic growth.

According to data gathered from the Federal Reserve Bank of St. Louis, from 2012 to 2016, commercial real estate prices rose by 5% every three months, while the Consumer Price Index stayed at 2%.

10. You Can Leverage A Lot In Commercial Real Estate

Why invest in commercial real estate? Because you can leverage a lot. Each monthly rent payment can be seen by the investor as a savings program if the commercial real estate asset has a mortgage with a fully amortized loan.

Rent eliminates the remaining debt and lowers the leverage of the asset. As a result, equity rises, bringing the investor back to the exit.

For instance, a property bought with 20% equity and 80% debt only needs to increase in value by 20% to reach 100% equity. Naturally, if payments are missed, there is a chance of foreclosure.

11. Commercial Real Estate Allows Investing Jointly With A Sponsor

People used to have to start from scratch when they wanted to invest in commercial real estate, looking for profitable properties, managing them, or hiring a broker. The JOBS Act of 2012, however, has altered that.

It was never the best approach, anyway. In order to purchase, sell, operate, manage, or enhance commercial properties, the average investor lacks the necessary infrastructure and expertise.

Co-investing with top-tier sponsors is the best practice when purchasing commercial real estate. The biggest investors in the world today don’t operate alone. Crowdfunding allows investors to pool their resources with those sponsors who have experience in the field.

Trion Properties, a private equity investment firm, is a top-tier sponsor for people looking to invest in commercial real estate.

On a mid- to long-term investment horizon, they purchase properties that need moderate to heavy rehab. They concentrate on increasing the property’s net operating income in order to maximize investor returns.

It’s a great way to generate passive income and build wealth over time to co-invest with a sponsor.

12. Commercial Real Estate Only Operates For A Short Period

Businesses typically close up shop at night. You, therefore, work when they work. You shouldn’t have to worry about receiving a late-night call from a tenant asking for repairs or reporting a lost key, barring emergency calls for fire alarms or break-ins.

When it comes to commercial properties, it is also more likely that you will have an alarm monitoring service so that, in the event that something does occur at night, your alarm company can alert the appropriate authorities.

13. Triple Net Leases In Commercial Real Estate

Although there are some variations to triple net leases, the fundamental idea is that, unlike in the case of residential real estate, the property owner is not required to cover property expenses.

All property costs, including real estate taxes, are directly managed by the lessee. Your mortgage will be the only expense you have.

These types of leases are frequently signed by businesses like Walgreens, CVS, and Starbucks because they want to keep up with their brand’s look and feel.

Because they handle these costs, you as an investor get one of the lowest maintenance income producers for your money.

Although triple net leases are uncommon for smaller businesses and there are many different net lease options available at strip malls, these lease types are the best and are not available for residential properties.

How To Manage A Commercial Real Estate?

The owner must take full responsibility for managing the leased commercial property on an ongoing basis.

To find, manage, and keep tenants, manage leases and financing options, and oversee property maintenance and marketability, property owners may want to hire a commercial real estate management company.

Given that the laws governing such property differ by state, county, municipality, industry, and size, a commercial real estate management company’s specialized knowledge is beneficial.

Landlords frequently have to balance increasing rents while reducing vacancies and tenant turnover.

As a result of the need to modify space to meet the unique requirements of various tenants, such as when a restaurant moves into a building that was previously home to a yoga studio, turnover can be expensive for CRE owners.

How Real Estate Investing Brings Profits

A hedge against the turbulence of the stock market, investing in commercial real estate has the potential to be profitable. However, the majority of returns come from tenant rents, even though investors can profit from property appreciation when they sell.

Direct Investment

By owning the real estate, investors can make direct investments and turn into landlords. Those with substantial knowledge of the industry or those who have access to firms that do are best suited for direct investments in commercial real estate.

A high-risk, high-reward investment in real estate is commercial property. Due to the high initial investment required for CRE investing, such an investor is most likely a high-net-worth individual.

The ideal property is located in a region with high demand and low CRE supply, which will result in favorable rental rates. The value of the CRE purchase is also impacted by the local economy of the area.

Indirect Investment

As an alternative, investors can make indirect investments in the commercial market by owning a variety of market securities, such as exchange-traded funds (ETFs) and real estate investment trusts (REITs) that invest in stocks related to commercial real estate, or by making investments in businesses that serve the commercial real estate market, like banks and realtors.

Commercial Leases

Some companies own the structures they operate out of. The commercial property is leased, though, which is the more frequent scenario. The building is typically owned by an investor or group of investors, who then charge each business that uses it rent.

Commercial lease rates, which represent the cost to use a space for a specific amount of time, are typically quoted in annual rental dollars per square foot. Residential real estate rates, on the other hand, are quoted as an annual sum or a monthly rent.

Commercial leases typically last one year to ten years or longer, with office and retail space having lease terms of five to ten years as the norm.

This can be contrasted with residential leases that are more frequently annual or month-to-month.

According to a study by real estate market analyst CBRE Group, the length of a lease is inversely correlated with the size of the space being leased.

The data also demonstrated that, in a rising market environment, tenants would sign long leases to lock in prices. But it’s not the only thing that motivates them. Due to the scarcity of properties that meet their needs, some tenants who need large spaces sign long-term leases.

There are four main categories of commercial property leases, and each has a unique set of obligations for both the landlord and the tenant.

What Distinguishes Commercial From Residential Real Estate?

Private living accommodations are the only use for residential real estate. Any property used for commercial purposes is referred to as a commercial real estate.

Hospitals, manufacturing facilities, storage facilities, retail establishments, office buildings, and other business establishment locations are examples of commercial real estate.

Is Investing In Commercial Real Estate A Wise Decision?

It certainly is possible. Commercial real estate can produce impressive returns and sizable monthly cash flows, and returns held up well during the market shocks of the previous ten years. Commercial real estate does, however, carry risks, just like any investment.

Final Thoughts

Real estate specifically used for commercial or revenue-generating endeavours is referred to as commercial real estate.

Because it has the potential to bring in rental income as well as capital growth for investors, it differs from residential real estate. Office space, industrial space, multifamily rental properties, and retail properties are the four main types of commercial real estate.

Commercial real estate investing can be more complex than residential real estate investing and typically requires larger capital investments from investors.

However, it can also yield high returns. For those without specialized knowledge of the industry, publicly traded REITs are a viable way to indirectly invest in commercial real estate.

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Adam is an internationally recognised author on financial matters, with over 760.2 million answer views on Quora.com, a widely sold book on Amazon, and a contributor on Forbes.