The average commercial real estate investor doesn’t target multi-million dollar high rises in Lower Manhattan. In fact, they typically choose reasonably-priced multi-family properties, retail stores, or office buildings in their local market.
While the skyscrapers in New York City might be one of your investing goals down the line, it’s important to be realistic when you’re just getting started with commercial real estate investing. After all, you may not have the skills to manage larger properties in bustling cities just yet.
More than likely, you’ll need to get your commercial real estate investing career started with smaller commercial properties. This article will teach you the basics of commercial real estate investing and seven tips on how to make money in commercial real estate.
Why Invest in Commercial Real Estate?
Commercial real estate has drawn increasing attention since the Covid-19 pandemic began. Retail stores and office buildings started shutting down due to work-from-home mandates, and many large companies had to terminate their leases permanently.
The loss of high-quality tenants led to property owners taking major losses and forced some to sell their commercial holdings at a significant loss to savvy investors. Thus, it still may be a great time to get involved in commercial real estate investing and take advantage of the post-Covid investing market.
Here are some additional reasons to invest in commercial real estate this year:
One of the main reasons people are drawn to commercial real estate investing is due to the high returns that are possible. Large office buildings, retail stores, or apartment complexes attract multiple tenants who sign long-term leases that generate significant rental income for investors.
Additionally, commercial real estate has the potential for property appreciation that generates larger returns compared to residential properties. This property appreciation has also been shown to consistently outperform the returns of traditional investments like stocks and bonds.
Commercial properties typically generate steady rental income that can provide a reliable source of cash flow for investors. This income can be used to cover operating expenses, debt service, and provide a profit for the investor.
Additionally, this cash flow can be used by investors to purchase additional properties to grow their commercial real estate investing business. It can also be used to hire property managers, maintenance contractors, and in-house lead generation teams.
Hedging Against Inflation
As inflation continues to outpace the rise in income and the cost of living, consumers are quickly finding out that they may not be able to continue to afford the lifestyle they’ve become accustomed to. Many are turning to side hustles and the gig economy to make up for the effects of inflation.
Luckily for commercial real estate investors, their investments serve as a hedge against inflation, as property values continue to rise over long-term economic cycles. This hedge can help protect the purchasing power of commercial real estate investments and help to build financial security.
As with any type of real estate investment, there are tons of tax advantages that commercial real estate investors can take advantage of.
Common tax write-offs for commercial real estate include depreciation deductions, interest expenses, and the ability to use 1031 exchanges to defer capital gains taxes.
Commercial real estate investing goes beyond monetary gains. It also offers investors the ability to network with other savvy investors and increase potential opportunities down the line. Some commercial real estate investors use their connections to secure new deals and refer properties to other investors who may be a better fit for the investment.
Risks of Commercial Real Estate Investing
Although there are tons of benefits when it comes to commercial real estate investing, there are also risks that you must consider before getting started.
- High Initial Costs: Commercial properties typically require a significant upfront investment, including the purchase price, closing costs, and potential renovations or improvements. This can make it difficult for smaller investors to enter the market.
- Limited Liquidity: Commercial real estate is generally less liquid than other investments like stocks or bonds. Selling a commercial property can be a long process, and finding a buyer willing to meet your asking price may be challenging in economic downturns.
- Tenant Risks: Finding and retaining reliable tenants is crucial for generating consistent rental income. Rent payment issues or disputes with tenants can affect cash flow and require legal action or property management efforts.
Considerations for Commercial Real Estate Investors
You know the risks and rewards, so do you still want to learn how to make money in commercial real estate? Here is everything you need to know about the considerations before securing your first commercial real estate deal.
Location and Demographics
Location is one of the most critical factors in commercial real estate investing. Property values are heavily influenced by their proximity to transportation, food and dining districts, shopping malls, and other key amenities.
Additionally, area demographics play a key role in rental income and property appreciation potential for commercial properties. Investors must consider demographic information like population trends and income levels to assess the viability of an investment in the area.
Real Estate Cycles
Real estate markets go through cycles of expansions, peaks, and contractions. It’s important for investors to understand where their particular market is in this cycle in order to make informed investment decisions.
During expansion cycles, the demand for commercial real estate properties remains high and rental income often increases for investors. As you might have guessed, contraction phases often exhibit opposite effects in the market. Investors should be prepared for the various real estate cycles and have a plan when the cycles change.
Zoning and Regulations
Real estate is a heavily regulated industry, and zoning laws dictate how properties can be used, developed, and modified. Commercial real estate regulations can vary significantly in different areas and affect your ability to use the property for your original intentions.
New investors should research local zoning codes and regulations to be sure that their property aligns with regulations in the area. Failure to do so can result in hefty fines and potential legal action from the state or local municipality.
Investing in Commercial Real Estate
You’ll need to understand what it takes to make sure you find the best deal with the highest potential for profits before learning how to make money in commercial real estate.
The biggest hurdle for new commercial real estate investors is the amount of capital needed to get started. Investors will need to gather enough resources to not only purchase the property, but also cover the down payment, closing costs, renovations, property management fees, and all ongoing expenses required to operate the property.
However, investors who don’t have the resources themselves can use their personal network of friends and family members as business partners who share in the profits of the investment.
If you have the necessary resources to purchase a commercial property, you’ll need to determine exactly how to finance it.
Since many commercial properties exceed $1 million or more in purchase price, buying the property in cash isn’t always the best option. Here are a few of the most common ways to finance a commercial real estate investment:
- Mortgage Loans: These are traditional loans from banks or lending institutions where you borrow money to purchase the property and repay it over time with interest.
- Commercial Loans: Specifically designed for commercial properties, these loans may have different terms and conditions compared to residential mortgages.
- Private Equity: You can partner with other investors or venture capitalists to pool resources for the investment.
- Seller Financing: In some cases, the seller may finance part or all of the purchase price to incentivize investors to follow through with the deal.
Market Research and Due Diligence
The market research and due diligence phase is arguably the most important part of the commercial real estate investing process. Savvy investors know how to study the market to understand the trends and market dynamics that influence the potential return on investment (ROI) on a property.
Due diligence involves investigating the property’s physical condition and financial history to verify the property is available for purchase. This includes inspections, title searches, lease agreements, and the verification of property ownership.
Creating an Investment Strategy
Investors should have a comprehensive investment strategy in place before securing their first commercial deal. This strategy plan outlines your specific investing goals and how you plan to achieve your objectives in the commercial real estate market.
Your strategy plan should include the property types to pursue, target locations, investment horizon, risk tolerance, and financial planning steps to ensure you keep your financial obligations and prevent overleveraging.
7 Tips for Making Money with Commercial Real Estate
Making money with commercial real estate doesn’t have to be a difficult process with the right strategy and guidance. Here are seven tips for making money in your commercial real estate venture this year:
Developing a comprehensive understanding of the commercial real estate market and best practices is the most important step in building a foundation for success in the industry.
Use resources such as books, podcasts, and online trainings to become familiar with commercial real estate and gain insights from industry experts.
Setting Clear Goals
As you know, setting goals and objectives will help guide you along the path to success. Ask yourself, are you looking for quick profits, consistent rental income, or long-term wealth creation? Answering these questions will help you stay focused and determined to stay on track.
Most commercial real estate investors fail to get started due to financial constraints. Luckily, we mentioned several ways you can get started without having to spend all your resources on one deal.
It’s important to make sure you have enough capital to cover upfront expenses as well as ongoing expenses like utilities, marketing efforts, property management, and insurance premiums.
One of the biggest mistakes investors make is putting all their resources in one commercial property. We recommend diversifying your portfolio by investing in different types of properties in various locations to spread risk and protect your investment if one property underperforms.
Choosing your tenants wisely is another make-or-break factor for your commercial real estate investment.
You’ll want to screen and accept tenants who have a strong financial background and a history of responsible tenancy, as reliable tenants can provide stable cash flow for years to come.
It’s crucial to identify and develop a plan to manage the risks of commercial real estate investing. This often includes having the right insurance coverage and maintaining the property to prevent injuries to tenants or costly repairs.
Investors should always have an exit strategy in place.
Whether you plan to sell the commercial property for a quick profit, refinance it, or pass it on to your children, having an exit plan allows you to anticipate the future for your investments.
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