Commercial Real Estate Investing For Beginners
by Michal Ben-Moshe, Senior Marketing Director
Posted on September 13, 2017 at 14:30 PM
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What Is a Commercial Real Estate Investment?
Commercial real estate is property that is used for business purposes and used to generate a profit. Commercial real estate properties include Single Tenant Retailers (such as restaurants, gas stations and convenience stores), Shopping Centers, Office Spaces, Multi Family Buildings, Hotels, Malls, Industrial Properties, Medical Centers, and more. If you are considering to invest in any type of commercial real estate properties then this article is just for you. We summarized some of the advantages, types and ways to invest in commercial real estate.
Commercial Real Estate Investment - Unique Benefits
Generally, the objective of investing in commercial real estate is to accumulate long term wealth and security and/or utilization for tax benefits. The first step to get started in commercial real estate investing is understanding the personal and financial benefits:
Higher Income: The first and most important benefit of investing in commercial real estate is higher potential income. Generally, commercial properties typically have a better return on investment (ROI) than other investment vehicles. By purchasing commercial real estate, an investor can generate a favorable and stable yield by leasing the property and from the appreciation of the property value over time.
Longer Leases: Commercial real estate assets generally have longer lease agreements with tenants than residential properties. Usually, the lease agreements are for multiple years, thus the risk for vacancy is lower and the amount of stable cash flow is higher.
Cash Flow: As mentioned above, commercial real estate has longer leases than residential properties. That means steady and reliable income on an annual and monthly basis. In some cases, there are zero landlord responsibilities, which means that the tenant pays all of the property expenses, such as real estate taxes, insurance and maintenance. That type of investment is known as a Triple Net Investment (NNN).
Tax Benefits: Commercial real estate owners have multiple Tax benefits. The investor can deduct nearly all the expenses he pays to manage his property, such as property mortgage interest, property depreciation, property repairs and more. In addition, a commercial real estate investor is able to avoid capital gains tax by trading one property for another according to 1031 Exchange of U.S. tax code.
Commercial Real Estate Types
Primarily, it is important to understand the difference between; Single-Tenant Properties and Multi-Tenant Properties. A Single Tenant Property is a property that is fully occupied by a single user and often features a Triple-Net (NNN) lease structure. Single-Tenant Net-Leased properties (STNL) are attractive to investors due to their low management responsibilities and long lease terms. In contrast to a single tenant property, a Multi-Tenant Property is a property that has two or more tenants. The pros are that they are more diversified and not limited to a particular tenant. The cons are that Multi-Tenant properties can require more management and can have shorter leases.
Second, there are few types of categories of commercial real estate that are important to understand. These categories include the following:
Retail Properties: This category includes single tenant retail buildings, such as restaurants, quick service resturants(QSR), pharmacies, small neighborhood shopping centers, larger centers with large anchor stores tenants, outparcels and even malls.
Multifamily Properties: This category includes apartment complexes, garden apartments, midrise apartments and high-rise apartment buildings.
Office Buildings: This category includes office buildings from all types and classes, from small to large high rises, central to suburban and Class A to C (Class A buildings are considered the best in terms of construction and location).
Industrial Spaces: This category ranges from smaller properties to the very large "big box" industrial properties. Also, this category includes Heavy Manufacturing spaces, Light Assembly properties, as storage, Flex Spaces which include a mix of both industrial and office space and Bulk Warehouses which are used for regional distribution of products.
Land: This category includes investment properties on undeveloped land, such as farm or pasture, infill land, which has already been developed but is now vacant, and brownfields, which was previously used for industrial or commercial purposes, but are now available for re-use.
Special-Purpose: This includes all other types of nonresidential properties such as hotel, hospitality, medical, self-storage, car washes, theme parks, marinas, theaters, community centers and more.
How to Start Investing In Commercial Real Estate:
In order to start investing in commercial real estate there are few important things to consider.
One of the most important aspects when considering to invest in commercial real estate is the physical location of the property. As long as the property is located in a highly populated area with strong and well-known tenants and with good traffic counts, it will always be easier to maintain tenancy. “At the end of the lease term consider that you will only keep the property itself, and therefore the physical location must be considered”, says Roee Ben-Moshe, a Senior Broker at The Ben Moshe Brothers of Marcus and Millichap. “Thus, it is important to analyze the location and make sure it is attractive for additional future tenants."
Secondly, it is necessary to look closely at the tenant. It is important to review the tenant credit information, payment history, tenant sales reports and security deposits. The stronger the tenant and the guarantee, the property becomes more attractive to investors looking for less risk.
Third thing to look at is the lease type. The most attractive lease is a Triple-Net (NNN) Lease, where the tenant is responsible for paying all property expenses. In addition, it is important to look at the lease term. The longer the lease is, the less you have to worry in the long term.
Fourth thing to look at is the Cap Rate or Capitalization Rate, which is a ratio of net operating income to property asset value. The higher the cap rate, the higher the returns will be. But it is important to understand that the higher the cap rate doesn’t necessarily mean a better deal. In other words, if the tenant on the lease has strong credit and guarantee, such as a strong corporate guarantee, the deal is less risky and thus more attractive. This can affect the price to be higher and thus the cap rate will be lower.
While researching the property and negotiating on the terms it is crucial to have a well experienced commercial real estate broker to represent you. The broker will most likely have a better understanding of the market, access to more recent information (such as sales and rent comps), and will assist in the negotiation process.
At last, after researching and understanding all the lease terms it is necessary to conduct a proper due diligence process, which includes reviewing financial and environmental matters, review of all pending litigation involving the property, selecting the title company and more. In that stage it is important to have an attorney and accountant to assist you.
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