How To Make Money With Commercial Real Estate Investing

Investing in commercial real estate can be a lucrative way to build wealth and diversify your investment portfolio. This sector comprises various property types, from office spaces and retail buildings to industrial units and apartment buildings.

It’s particularly attractive for busy, high-income earners (i.e., dentists and physicians) due to the potential for passive income, capital appreciation, and incredible tax benefits.

To make money with commercial real estate, it’s crucial to understand fundamental concepts. One of these is Net Operating Income (NOI), which represents a property’s revenue after operating expenses have been covered.

Additionally, understanding the financial implications of property acquisition, such as the required capital for securing financing, can influence the decision-making process.

To maximize returns in the industry, investors should also build a network of professionals, including brokers and developers, to identify the best deal opportunities. Many of these are found “off-market”.

Whether you’re a new or experienced investor, exploring commercial real estate property can lead to potential long-term wealth.

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5 Types of Commercial Real Estate

#1. Office Buildings

Office buildings are one of the most common types of commercial buildings. They can be categorized into three classes: Class A, Class B, and Class C.

Class A properties are typically new constructions or extensively renovated buildings located in prime areas with easy access to amenities and are professionally managed. Class B properties are older and typically require updates or renovations. Class C properties are even older and may need significant renovation or are located in less desirable areas.

#2. Retail Spaces

Retail spaces are designed for businesses selling goods and services to customers. These can range from small shops to large shopping centers (strip malls) and are often found in urban areas. Some examples include:

• Shopping centers: These can vary from strip malls to larger regional malls and may include a variety of stores.
• Stand-alone stores: These are not attached to larger shopping centers and are often found in busy locations.
• Restaurants and bars: Due to their unique needs, these businesses often require specialized retail space designs.

#3. Industrial Properties

Industrial properties are used for manufacturing, storage, and distribution purposes and can be broken down into the following sub-categories:

• Manufacturing: These facilities are designed for the production of goods and are often located in industrial parks.
• Warehouses: Buildings used for storage and distribution of goods.
• Flex spaces: Properties that combine office, showroom, and warehouse space to accommodate a variety of businesses.

#4. Apartment Complexes

Apartment complexes are considered a commercial property type (not residential) when they have five or more units. There are several types, including:

• Garden-style apartment complexes: Low-rise buildings often located in suburban areas.
• Mid-rise and high-rise buildings: These are usually located in urban areas with higher populations.
• Student housing: Apartment complexes near universities designed specifically for college students.

#5. Mixed-Use Developments

Mixed-use developments are properties that combine multiple commercial property types, such as retail, office, and residential spaces, all in one location. Examples include:

• Live-work units: These combine residential and office spaces within one property.
• Apartments above retail spaces: Allow residents to live close to shopping and other services.
• Office and retail developments: Offering businesses a combination of work and retail spaces within the same development.

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3 Investment Strategies For Commercial Real Estate

There are several investment strategies to consider when investing in the commercial real estate sector. By understanding each one, you can maximize your investment’s potential.

#1. Buy and Hold

This long-term strategy involves purchasing commercial real estate properties with the intent to hold them for an extended period, typically several years or more. During the hold period, steady cash flow is expected from rental income paid by each tenant.

Over time, the property’s value should appreciate, enabling the investor to sell at a profit when the time is right.

#2. Fix and Flip

The Fix and Flip strategy is popular for residential properties but also can be used for commercial real estate. It involves purchasing distressed or underperforming properties, making necessary improvements, and selling them for a profit.

The keys to success are targeting undervalued properties and having the resources to execute the renovation projects quickly.

#3. Development

The development strategy requires substantial capital as it involves ground-up construction or significant redevelopment of existing properties. Working with people knowledgeable about site acquisition, zoning, project management, and marketing is crucial.

When this strategy is successful, it can offer significant returns on investment. Still, they also pose greater risks compared to other methods.

Financing Options

Traditional Loans

In the world of commercial real estate funding options, traditional lending approaches are the most popular. These include conventional loans or those backed by the government through SBA’s popular 7(a) loan program.

To qualify for these types of loans normally requires a strong credit score of no less than around 600. Expect interest rates to vary based on the lender, the type of loan, and the property value.

Hard Money Loans

Hard money loans are short-term loans available from a hard money lender when quick access of funding is urgently needed.

This type of financing is as an attractive alternative through private lenders or investors with lower credit scores. Also, the interest rates can be higher as compared to traditional loans.

Real Estate Investment Trusts (REITs)

REITs are a popular financing option for those hoping to get into large scale commercial property investments while minimizing risk. Investors can buy shares in a REIT through the stock market allowing them to diversify their holdings.

Additionally, REITs must pay out no less than 90% of their taxable income as dividends—a valuable benefit for anyone who wants a predictable income source.

Exchange-Traded Funds (ETFs)

Exchange-traded funds are another way to gain exposure to the commercial property market without directly investing in properties. These funds invest in various real estate assets, including REITs, stocks of real estate-related companies, and real estate debt. ETFs are traded on stock exchanges, providing liquidity and flexibility for investors.

Partnerships

Forming a partnership can be a viable financing option for investing in commercial real estate. One or more partners contribute capital in a partnership, while others contribute specialized knowledge or skills. 

A limited partner (aka passive investor) typically provides financial capital but has limited liability and involvement in the day-to-day management of the investment. I’ve been involved as a limited partners in multiple real estate syndications. 

Partnerships can be an effective way to pool resources and spread risk. Still, working with an attorney is crucial to ensuring the partnership is structured correctly.

When evaluating different financing options for commercial real estate, investors should consider their risk tolerance, investment goals, and financial situation. 

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Evaluating Commercial Properties

Market Analysis

A market analysis is essential to understanding the property’s potential when considering a commercial real estate investment. This involves examining factors such as location, demographics, and competition. Investors should look at the neighborhood where the property is located, attend open houses, and speak to other property owners to gain insight into the local market conditions.

Property Inspection

It’s crucial to thoroughly inspect a commercial building to identify potential issues or maintenance needs. This process includes verifying the property’s square footage, checking for structural soundness, and assessing the overall condition of the building. Investors should also consider working with a professional appraiser to obtain the property’s accurate Gross Rent Multiplier (GRM).

The GRM is calculated by dividing the property purchase price by the gross annual rent, with a lower GRM indicating greater potential for a commecial investment, assuming all else is equal.

Due Diligence

Performing due diligence is a fundamental aspect of evaluating commercial real estate. This involves examining the property’s financial records, such as rent rolls, operating expenses, and occupancy rates. 

Furthermore, investors should review the property’s zoning and land use regulations to ensure compliance and identify potential rezoning opportunities. Using the income approach to valuation, investors can estimate the property’s potential rental income relative to the initial cash outlay, which is particularly useful for commercial property valuation.

Managing Commercial Properties

Lease Agreements

When dealing with commercial real estate, it’s essential to have well-drafted lease agreements for the tenants. These should outline the terms and conditions of the tenant’s occupancy, including rent, lease duration, renewal options, and any other pertinent details. This will ensure both parties have a clear understanding of their rights and responsibilities, reducing the likelihood of disputes in the future.

Property Management

Hiring a professional property manager is often a wise decision. They can handle the property’s day-to-day operations, including collecting rent, overseeing maintenance and repairs, and staying current with local regulations that may impact the property. 

Tenant Relations

Maintaining positive relationships with commercial tenants is crucial to the success of commercial real estate. This can be achieved through open communication, addressing any concerns or issues promptly, and working to resolve disputes amicably. Some practices to maintain good tenant relations include:

• Regularly checking in with tenants to address any concerns or issues
• Keeping the property well-maintained and attractive to tenants
• Being responsive to maintenance requests and repairs
• Offering incentives or assistance to tenants, as needed
• Consistently enforcing lease agreement terms and conditions

Incorporating these strategies into the management of commercial properties can lead to increased tenant satisfaction and retention, helping to ensure a stable and profitable investment.

Risk and Return

Cash Flow

Investing in commercial real estate can generate steady cash flow through rental income. Tenants often sign long-term leases, providing investors with a reliable and consistent income stream. Cash flow depends on property location, tenant quality, and lease terms. 

Passive Income

Commercial real estate can provide passive income, as property owners don’t actively participate in the day-to-day management. Instead, they can hire professional property management companies to deal with tenants.

Tax Benefits

Commercial real estate investments offer multiple tax benefits, which can increase overall returns:

• Depreciation: Property owners can write off a portion of the property’s value annually to account for wear and tear, lowering their taxable income.
• Interest expense deductions: Investors can deduct mortgage interest expense from taxable income.
• 1031 Exchange: A 1031 exchange allows investors to defer capital gains taxes when selling a property and reinvesting the proceeds in a similar property.

Note that specific tax benefits will vary based on the investor’s individual situation, and consulting with a tax professional is recommended.

Appreciation

Property appreciation is the increase in value over time, another way commercial real estate investments generate returns. Factors affecting appreciation include:

• Supply and demand in the area
• Economic growth and job creation
• Infrastructure improvements
• Property improvements made by the owner

It’s important to note that appreciation is not always guaranteed and can vary depending on market conditions. Investing in areas with strong demand and growth potential can increase the likelihood of appreciation for a commercial property.

In conclusion, commercial real estate investments offer various ways to earn returns, including cash flow, passive income, tax benefits, and appreciation. Investments can generate substantial returns through commercial real estate investments by understanding and managing the associated risks.

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Building a Diverse Real Estate Portfolio

When building a diverse real estate portfolio, it’s essential to consider various commercial real estate sectors and select an assortment of assets. Diversification within your portfolio can help reduce risk and improve your potential for financial success.

Begin by exploring various sectors, including office buildings, retail centers, industrial properties, and multifamily apartments. Each possesses its own risk-reward profile, and diversifying amongst these sectors can help stabilize your investment returns.

Focusing on specific property types within these sectors can further diversify your portfolio. For example, within the office space, you could invest in both urban and suburban properties and others varying in size and tenant type.

Additionally, consider investing in both single-tenant and multi-tenant properties for further diversification. While single-tenant properties usually have a more stable income stream, multi-tenant properties can provide an additional layer of safety as the risk is spread across multiple tenants.

To further enhance your portfolio diversification, seek investment opportunities in various geographic locations. This strategy helps to mitigate the impact of local market fluctuations and reduces exposure to specific regional risks.

Getting Started

Building a Team

Building a solid team is crucial for success in the commercial real estate industry. Your team should consist of knowledgeable professionals, each with their own area of expertise. Key members to consider are:

• Real estate agent: It is essential to have a licensed real estate agent experienced in commercial properties guide you through the process, negotiate deals, and bring valuable market insights.
• Attorney: A legal expert will help you navigate the complex legal landscape, draft contracts, and review legal documents.
• Accountant: An accountant will assist in managing your financial activities, such as tax planning and financial analysis.
• Property manager: A property manager can be a valuable asset for managing day-to-day activities and property maintenance.

Choosing the Right Property

Choosing the right commercial property is one of the most important steps for investors. Consider the following factors to ensure a lucrative investment:

• Location: High-traffic, easily accessible areas with strong economic growth prospects will likely attract more potential tenants.
• Property type: Decide on which type of commercial property you want to invest in, such as office buildings, retail spaces, or industrial properties, based on your expertise and market demand.
• Financial analysis: Thoroughly analyze the property’s income potential, expenses, and return on investment (ROI) prospects.
• Condition and maintenance: Gauge the current state of the property and evaluate the costs associated with repairs, upgrades, and ongoing maintenance.
• Market trends: Keep yourself updated on market trends, including supply and demand dynamics, to make informed investment decisions.

Bottom Line

In summary, commercial real estate investing offers substantial wealth-building opportunities. It necessitates a solid understanding of crucial concepts, diverse financing options, and various property types. Efficient property management, from lease agreements to tenant relations, is essential for stability and profitability.

Commercial real estate investments provide considerable returns through steady cash flow, passive income, tax benefits, and potential property appreciation when properly executed.

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