2. How to Get Started in Commercial Real Estate Investing?
CREs are usually leased to tenants for operation of their businesses. CRE includes tenants of all kinds like space for offices, banks, malls, restaurants, and convenience stores or supermarkets. It has become an appealing investment option because of its coherent returns, pliable source of income, and growth prospects.
Though investing in CRE is attractive, there are some common hiccups, mistakes, and risks involved. Therefore, it is important to you know how to get started and what should you look out for before investing in CRE especially for the first timers.
Financial Ineptness:
It is always advisable to keep a track of your capital as well as your expenses for having an idea of the amount of cash which you can invest.
Realistic Goals:
Every investor has a different set of goals. These goals should be realistic in nature considering all the factors and should have a realistic deadline.
Knowledge of Risks:
Create a perfect strategy which determines your risk bearing attitude.
Exercise Due Diligence:
A prospective buyer can always conduct thorough research on CRE regarding the actual investment opportunity, availability of finance, property inspection, documents, tax returns, profit, and loss statements from the previous owner, survey reports, feasibility study, and so on.
Updated knowledge of Market Cycles With Latest Trends:
To invest in a CRE, it is important to learn how the cycle of the real estate market works and the latest trends in the sector.
Proper Valuation of a CRE:
Every CRE investment depends upon the supply and demand, yield from it, and the overall profitability of each sector as all these parameters vary greatly.
Ensure you Have a Capital Reserve Fund and a Contingency:
and capital reserve fund can help a person through phases of unexpected expenses like lease or rent hike, change in management, renovation, change in location or building a new structure.
3. Pros and Cons of CRE Investing
They are the pros and cons of CRE investing. So, let us have a look at them.
Pros of CRE Investment:
They are the pros and cons of CRE investing. So, let us have a look at them.
In a commercial property its earning potential depends on the type of property like shop or office space and parameters like right location and right price.
- Tenants With High Professionalism:
Tenants of CREs are usually corporates, business houses, banks, retail chains, and so on. Since they belong to a corporate culture, they know how to deal professionally with the owner/investor.
- Stable and Regular Returns:
Usually a commercial property carries a lease agreement for a long-term that is a minimum of 5 years with a clause of increase in the yearly lease whatever the market conditions be.
- Leases With Flexible Terms:
Lease agreements with CRE are very flexible in their terms and the tenant is liable to handle all property related expenses, real estate taxes, and so on.
- Almost no Cost of Furnishing:
The furnishing cost of CRE is almost nil as you hand over the unit as it is to the tenant. Tenants who are usually corporates or business houses or banks or retail chains can furnish the property with the layout of their own.
- Maintenance of the Property:
Tenants of CRE have an interest in maintaining the property to live up to the expectations of the locality or area in which they operate further help to enhance the value of the property for the investor.
Cons of CRE Investment:
Below given are a few disadvantages of the investment in CRE
A commercial property is costlier than a residential property as it may need some maintenance expenses.
- Difficult Buying Process:
Thorough research and detailed planning must be done to buy a commercial property as against a residential one. The location, demand and supply for a CRE in a specific location, the nature of the business are the important criteria which a buyer must investigate and judge the property on their basis.
The fate of commercial property is linked with the fluctuation in the economy. If there is a slack in the economy, then the demand for commercial space reduces and vice versa.
- Higher Rate of Interest Loans:
In case if an investor wishes to use a loan for buying a commercial property then he will have to get the same at a higher rate of interest.
- Ratio of Loan to Value (LTV):
The commercial property has an average LTV of 60% in comparison to 80% for residential properties making it costlier.
There are no tax benefits on the purchase of a commercial property based on a loan as against a home loan thereby increasing the overall cost of borrowing.
- Not Easy to Sell or Find a Tenan:
A commercial property may pose a problem of non-availability of a good buyer or a tenant. Selling may take a longer time. considering the size of the commercial property
An investor, must look into the manner of the property conservation and maintenance as it influences investment returns.
Though it is riskier to invest in CRE in comparison to a residential property, once you have bought it you have unearthed a treasure for yourself.
4. Should I Invest in Commercial Real Estate?
Investment in commercial real estate is gaining popularity in the real estate segment of investment. Real estate investment has its own complexities by way of issues in liquidity, maintenance, transparency, and high prices. For anyone who wants to invest in the CRE, a thorough consideration must be given to the risk bearing capacity, the type of investment whether long term or short term, and the purpose of investment. For those who are considering stability, low risk with low returns, and buying a small space, investing in CRE is ruled out.
The potential buyers of CRE can be
- Business owners in need of new or larger premises.
- Investors who are looking forward to expanding their portfolio.
- New investors to CRE who are interested in buying into a portfolio.
5. Why is Commercial Real Estate So Expensive
Commercial properties are expensive in comparison to residential properties. There are many factors which one can consider proving the expensiveness of a commercial property.
Commercial properties are usually large in size, more difficult to build, needs a lot of capital to build, as they provide more substantial services and are resourceful. Commercial properties are rented or leased mostly to corporates because they can afford to pay more rent or go in for a longer lease tenure. The location plays a prime role in determining the cost of the CRE in both ways while purchasing and renting it.
6. Features of a Profitable CRE Investment
Real estate investment is a tough call to take and therefore it is very important for a foreign investor to do detailed research before taking a plunge into the investment.
Let’s have a look at some of the features of a profitable CRE investment
- Location is very good for rent and capital appreciation
- A good Quality CRE attracts a premium quality of tenants.
- Demand and Supply are proportionate to each other in CRE.
- Comparison of rents between the current ongoing market rate and the rate or rent which is being demanded from the investor.
- Quality of tenants pay rent on time, also pay higher deposits, and stay for a longer period there by increasing the value of the property.
- Structure of lease with a 9 year or a 15-year lease with rise every 3 years or 5 years.
- Security Deposit for any CRE varies between 10 to 12 months of the rent
- Diversification helps. Investing in multiple properties will reduce the risk factor at the property level as well as there will be a variety in income.
- An investor need not to worry about the interiors or the furnishing of the property. It all depends upon the tenant’s choice, taste, and company guidelines if any.
Keeping these features in mind let us now learn how to make money in CRE.
7. How to Make Money in Commercial Real Estate?
Following are the ways in which you can make money in commercial real estate even if you are walking on a tight budget
- Publicly traded REITs are a safe bet to purchase their shares.
- If you want to start small, then try joining another investor for buying a smaller apartment or building.
- Buy bank-owned properties that are taken back by banks for foreclosure.
- Become a powerful money lender.
- Join a group of crowdfunding individuals
- Buy a CRE which is a pre-foreclosure property. These properties are those where the owner is having several mortgage payments due and therefore properties are about to be foreclosed.
- Auctions are helpful in finding out lucrative CRE properties. Buy properties that are being auctioned by court procedures.
- Here is an interesting term called the ‘lease option sandwich’ which allows an investor to sell the property without being the owner of it.
- Using due diligence buy a small retail store or an office with good potential of return.
- Buy a CRE which is a property financed by a seller.
8. A comparative Study with Traditional RE
Commercial Real Estate Vs Residential Real Estate
The major technical difference between residential and commercial property is that a residential property relates to family homes or residences. Examples for which are duplexes, condos and quadruple access. Whereas a commercial property is for commercial purposes only and not for residences. These properties are rented to offices, retail outlets, industrial or business houses, malls, or hotels and even hospitals.
Another difference between the two is that a residential property is a single unit property whereas a commercial property is a multi-unit that is having five or more units at a stretch.
Type of tenants attracted by the residential and commercial property are strikingly different. While residential properties are typically rented out to families and individuals, commercial properties are leased out to professionals and business houses.
Each property arrives with different kinds of opportunities. Commercial real estate awards it’s investors with high monitory gains whereas residential real estate allowed its investors to use the property to its maximum potential.
Benefits of Investing In Commercial Real Estate
Following are the benefits and drawbacks of investing in a commercial property. The reason for giving a comparative study is to prove that there are more benefits than drawbacks of investing in CRE.
Benefits and Drawbacks of Investing in Commercial Property
Benefits
- Earns a higher rental yield plus returns
- The lease term can be longer i.e., Nine years to fifteen years
- The property can be unfurnished or with minimum furnishing
- Value of a CRE is not volatile
- The premium quality of tenants
- Limited hours of operations ensure an early closing of the CRE units or facilities.
- Flexibility in the lease terms towards security deposits and rules for termination
- Regular steady income flow with the uninterrupted yearly rise in lease.
- Excellent appreciation of the asset value in case of holding it for a long time
- Provides protection against inflation
Drawbacks
- The capital values of CREs tend to remain stable for a longer duration
- The property may be required to have a specific minimum size for being commercially viable
- May be difficult to sell or rent for the want of appropriate buyers
- There may be an initial bigger investment.
From the above comparative study, one can see that investment in CRE is highly beneficial and buying a real estate is not only the best or the quickest or the safest way but the sole way to become rich.
9. Types of Commercial Real Estate Investments
Are you ready to make a smart move? Are you ready to add investment in CRE in your investment portfolio to diversify be protected against market volatility?
Yes!! So, if you’re ready to become a real estate King let us look at how the different property investments can help you out
10. CRE Due Diligence and Things to Consider
Due diligence is a process of doing thorough research before buying the property. It is a process where the investor investigates in detail, checks, and verifies any important information relating to the property before giving it consideration.
Due diligence process can be categorised into five steps followed by the investor in any order. Let us have a look at them
Operational Due Diligence:
This step is taken to ensure that the investor has the best team available to execute his business plan. It involves hiring professionals, selecting an appropriate property manager, going into the details of the existing management of the property, investigating the lease terms, going through the local market competence, and the types of tenants and their affinity with each other.
Financial Due Diligence:
It requires to investigate property’s finance by looking into the details of the property’s cash flow ensuring that it matches with the seller’s representation of income and expenditure and helps in determining the sustainability of the property’s rent. Several audits also go into it.
Legal Due Diligence:
It is a step taken to ensure the validity of entitlements and obligations as regards the owners as well as to investigate details like title transfer which includes a survey of the property to collect the latest possible information of the site and breach of any access rights to the site or any other complication.
Physical Due Diligence:
Appointment of a certified engineer and an appraiser is done to visit and physically inspect the property. The engineer will inspect the property’s current physical condition, need for any repairs or renovations, and so on. The appraiser will at the same time review historical operations of the property and take up the calculation of current rent roll analysing the fundamentals of the market.
Environmental Due Diligence:
A geologist identifies any potential environmental issues, the property’s historical use, any environmental contamination in the past or any future contamination, state of the site and the underlying soil, the groundwater and soil testing and the actual condition of the land at the time of ownership prior to the acquisition of the property.
11. Understanding CRE Investing Loans & Finance
Let us have a look at how a commercial real estate loan differs from residential loan by way of its characteristics and what do the lenders look for.
Individuals vs. Entities:
Residential mortgages or loans are usually given to individual borrowers. Commercial real estate loans are offered to business entities like corporations or developers or partnerships funds and trust
Schedules for Loan Repayment:
A residential loan or a mortgage is a type of amortize loan in which repayment is done through regular instalments over a period of time.
Commercial loans on the other hand range from 5 to 20 years and their amortization. is often longer than the actual term of the loan.
Loan-to-Value Ratios:
Loan to Value ratio shows (LTV) is a measure of the value of a loan as against the value of a property. For both commercial and residential loans, borrowers with lower LTVs are the most qualified for the most advantageous financing rates available as against those with higher LTVs.
Debt-Service Coverage Ratio:
Commercial lenders as against residential lenders consider the Debt Service Coverage Ratio (DSCR) to compare the net annual operating income of the property to its debt service annual mortgage which includes the principal as well as the interest.
Interest Rates and Fees:
Commercial loans usually bear a higher rate of interest as against residential loans.
Pre-Payment:
A commercial real estate loan as against residential loans maybe designed to have several restrictions on its prepayment
