Getting started in commercial real estate investing is an exciting prospect, but can be confusing for new investors. Having an understanding of what is involved will help you avoid costly mistakes.
Commercial property investments offer many benefits including longer lease terms, lower vacancy rates, and steady cash flow. This type of investment is best for investors who are looking to generate passive income.
1. Know Your Objectives
Commercial real estate is a great way to diversify your portfolio and earn passive income. However, it is important for beginning investors to know what their goals are before jumping into the industry.
Unlike residential properties, commercial property investments typically yield a higher cash flow. However, they also require a larger down payment and are often more expensive to purchase and maintain than single-family homes. This may make them a better option for high-net-worth individuals who can afford to take on more risk and potentially reap a greater reward.
Additionally, commercial property investments tend to have more steady income streams as a result of longer leases than residential properties. Losing one tenant in an apartment building or office building only affects your income by a fraction of that of a single-family home.
In order to understand the return potential of a particular commercial property, you will need to understand the concept of net operating income. This calculation includes all revenue minus all operating expenses such as insurance, property management fees, maintenance costs, janitorial services and more.
2. Research the Market
Commercial real estate investing isn’t for everyone, and it takes a substantial amount of time, effort, and money to get started. But, if you’re willing to put in the work, you can make the most of this traditionally powerful investment strategy.
The most important step for any newbie in commercial real estate is learning the market. Researching the local area will give you a better idea of the current market conditions and whether or not it’s a good time to invest.
Additionally, you should understand how to calculate the key financial metrics of commercial property investments. These include net operating income (NOI), cash on cash return, cap rate, and debt coverage ratio.
Beginners can also consider REITs or crowdfunding as a way to break into the industry. However, if you plan to take this route, it’s essential to keep in mind that asset performances will fluctuate, depending on economic factors and market cycles. This is particularly true for REITs, which can be exposed to additional risks. For example, REITs are subject to stock market volatility, whereas direct investments in CRE will not be as vulnerable.
3. Do Your Due Diligence
Commercial real estate investing offers many benefits for investors, including high returns, tax advantages and instant portfolio diversification. However, the industry comes with its own set of risks, and it is important to understand those risk factors and do your due diligence before making any investment decisions.
Performing your due diligence entails a thorough investigation of all aspects of a potential property. This includes inspecting the physical property, evaluating the market, and reviewing financials. It also involves evaluating the seller’s reputation, standing and track record. For instance, you will want to examine service contracts, financial reports and any past litigation or bankruptcy proceedings.
The amount of time needed to conduct a full due diligence process varies depending on the type of investment, but you should always allow for unforeseen expenses and a cushion for potential problems. For example, a property that requires major structural repairs may require a larger down payment or more financing than you originally anticipated. It is important to establish a due diligence deadline and set aside enough time to complete the investigation.
4. Make the Offer
Commercial real estate investments can be lucrative and offer a hedge against market volatility. They also provide passive and active income opportunities, allowing investors to make money through property appreciation, rental income, or both. However, CRE investing typically requires more capital, expertise, and time than many beginner investors have.
The most common way to get started with CRE is through a direct purchase. This involves becoming a landlord by purchasing and owning the physical asset. Investors may choose to actively manage the property or hire a professional management firm to do it for them. Investing in CRE is a high-risk, high-reward investment for those who have the resources to do so.
Another popular way to start investing in CRE is through a REIT or other passive investment option. These strategies allow beginners to invest in commercial real estate without having to be a landlord or take on the risk of buying an individual property. These investment options can include REITs, crowdfunding, private equity firms, and specialized investing websites. Each has its pros and cons, but they all allow investors to diversify their portfolio with the potential for higher returns and tax benefits.
5. Negotiate the Contract
If you are a new investor, it is a good idea to get an advisor who specializes in commercial real estate. They will help you find a property that meets your goals, and they can also negotiate on your behalf. They will be able to read the seller’s body language and know how to present your offer in a way that is most likely to succeed.
It is also important to understand how a PSA (purchase and sale agreement) works. This is a complex document that has many legal ramifications. It is a best practice to have a lawyer review the PSA before signing.
While it may be tempting to save money by having your handy brother-in-law do an inspection or asking the clerk at your bank for mortgage rates, these mistakes can cost you in the long run. Experienced professionals can save you money in the short term, and they will protect you from costly mistakes in the future. This can make the difference between success and failure in commercial real estate investing.