If you’re a real estate agent or investor that’s considering branching into the commercial market, there are a few details you should think about before you dive in head first.
Real estate, in general, is considered a smart investment. Property is a tangible asset with a value that usually appreciates over time, regardless of other economic factors. It’s ideal for building a retirement nest egg and can result in some substantial tax breaks.
Buying and selling commercial property has some similarities to working with residential real estate, but there are a few vital differences. Being prepared can help you receive the biggest return on your investment of time and money.
Here are five crucial facts about investing in commercial real estate that will put you on the path to success.
There’s Varying Profitability
Knowing when and what kind of commercial property to invest in will make a huge impact on your bottom line. There are many different types of commercial real estate (CRE), and some are vastly more profitable than others.
CRE is typically classified into five categories:
- Industrial
- Multi-family
- Office
- Hospitality
- Retail
While retail space was once king of the heap, with plenty of investors making loads of cash owning shopping malls back in the day, consumers now prefer to do the majority of their shopping online. Many formerly bustling retail properties now sit empty and forlorn.
The hospitality category includes restaurants, resorts, hotels, retirement communities, salons, and more. These can be highly lucrative places to invest, depending on your location.
Industrial space is currently the most profitable (all else being equal), and to cut down on risk, it’s best to invest in a property that has multiple tenants. Multi-family housing is a good bet right now as well as many markets are seeing a lack of affordable residences for rent.
Due Diligence is Critical
Every real estate market is different, and what is doing gangbusters in one area might fall flat in another.
It’s extremely important to do your research and get a feasibility study performed by experienced professionals. This will evaluate the demand generators, future growth, and the likelihood of profitability.
Conducting thorough research before making a commitment can save you a literal fortune. There are many reputable companies that can delve into every aspect of your potential CRE investment to determine whether or not it’s a sound investment. In addition, having a knowledgeable real estate team on your side will give you a world of benefits.
There are many aspects to an in-depth feasibility study, but here are a few of the most common:
- Profit and loss statements from the previous owner
- Potential zoning issues
- Permitting and other municipality regulations
- Land surveys
- Inspection and appraisal of any current structures
- Market comparables
- Timelines
Ask other real estate professionals and investors in your area for recommendations on companies that have a reputation for insightful feasibility studies.
To Work with a REIT or Go It Alone?
A real estate investment trust (REIT) is similar to a mutual fund, in that they pool the capital of numerous investors to purchase and maintain multiple income-producing properties.
REITs are perfect for those who want reliable passive income and more liquidity. These funds invest in almost all real estate property types, from corporate skyscrapers to timberland and medical facilities, and it’s a great gateway into CRE investing if you have little experience or time.
However, REIT investments don’t provide the same capital appreciation as sole ownership of a property. Also, the dividends are taxed as regular income and many REITs have astronomical administrative fees.
You should also verify the REIT is registered with the Securities and Exchange Commission. The SEC’s EDGAR database is easy to use and allows you to verify and review the fund’s financial reporting before you sign on.
You’ll Need a Contingency Fund
If you’ve diversified your portfolio with CRE, especially office space or multifamily residences, and you’re the sole owner, you should ensure that you have a substantial contingency fund, sometimes known as a tenant improvement escrow.
It can also serve as a capital reserve if it will take the property a little while to show a profit or if there are unexpected expenses. In addition, many tenants will require improvements or changes to a unit before they commit to a lease, especially a long-term one.
Here are some of the most requested leaseholder improvement demands:
- Painting
- New flooring
- Electrical upgrades
- Countertops and cabinetry
- Plumbing
Some of this work can give you tax advantages — consult with your accountant or tax advisor to ensure you’re getting the biggest possible benefit. Always be sure to get documentation and receipts from your contractors to mitigate the risk of getting hit with a mechanic’s lien.
It’s a Long Game
CRE can be one of the safest places to put your money, especially as part of a diversified portfolio, but it’s a long-term investment. Beware of any prospectus that advertises instant big returns.
As an alternative to stocks and bonds, real estate provides a safe harbor through bear markets and uncertain times, making it an attractive option for many investors.
But unlike investing in the hottest tech stocks and unloading them quickly when they reach a high value, CRE takes time to acquire and should be held for at least five years. Stable and steady are the keywords when it comes to commercial real estate.
If your industrial or hospitality real estate is in a highly desirable location, you might be able to lease it out for twenty years or more. Ideally, you’ll receive both monthly cash flow from rental income and future equity from the appreciation of your property.
Find the Right Partner
Ask almost any millionaire, and chances are they’ll tell you they owe at least part of their wealth to smart commercial real estate investments.
But buying the wrong property can result in heavy financial losses if you don’t have the right advice from an experienced and knowledgeable team of professionals.
Working with an organization like Landtrust Title Services as a real estate agent moving into the commercial space or as an investor looking to grow your portfolio will help guarantee you make all the right decisions.
If you’re interested in exploring the commercial real estate market in Illinois or Wisconsin, reach out today to learn more about how we can help!