How to Invest in Commercial Real Estate
One key factor for successful commercial real estate investing is identifying market trends.
By Paulina Likos |
April 13, 2021, at 3:18 p.m.
Commercial real estate can be rewarding, but beginners should also be aware of the investment risks.(GETTY IMAGES)
The commercial real estate market is quite different than the stock market, but similar investment risks and strategies still apply.
The appeal of investing in this property type is multifold. Investors can generate higher investment returns and take advantage of tax benefits by investing in different asset classes or property types.
Commercial real estate investing involves putting money toward purchasing commercial real estate property, including office buildings, multifamily apartment buildings, hotels, malls, storage facilities and shopping centers, among other property types.
If you're interested in this type of investment, you must be committed to having the commercial real estate holding invested for the long term.
Given that commercial real estate is an illiquid asset, your money may be tied up for a significant period. Illiquid investments tend to generate higher returns over time and are not subject to daily price volatility, but some opportunities may have a higher barrier to entry. If you're looking for more liquid investments, commercial real estate may not be the best option for you.
Real estate as an asset class can be a rewarding investment. But beginners should be aware of the investment risks involved with this real estate property type. Here's what you need to know about commercial real estate investing to determine if it's right for you:
How to get started in commercial real estate investing.
Risks and rewards of commercial real estate investing.
Should you invest in commercial real estate now?
Before taking the plunge into commercial real estate investing, it's important to ask yourself several questions.
Jeff Bartel, chairman and managing director at Hamptons Group, an alternative investment and advisory firm headquartered in Miami, says you should identify whether you prefer a crowdfunding approach or investing in a single property.
Investors who choose to crowdfund with a group of others should "look at the track record of the firm they're investing with," Bartel says. "Recognize fully their rights and obligations concerning (whether to) withdraw or not withdraw their funds from the investment during the period of time."
For those investing in a single commercial property, Bartel recommends identifying unique characteristics that "improve or detract from the attractiveness of the property or trends in the area that could be problematic."
Many professionals in the commercial property business got their start through single-family rentals, including Paul Getty, president and CEO at First Guardian Group in San Jose, California.
"Well over 90% of commercial real estate investors start with single-family rentals and use it as a way to get educated, accumulate wealth and work their way up to investing in other properties," he says.
While investing in residential real estate is much different than investing in commercial property, building a foundation in residential real estate can prepare you for commercial property investments.
Another avenue: Technology is providing many new investors, with varying levels of experience, the opportunity to get their feet wet with commercial real estate investing.
Applications such as Fundrise, CrowdStreet and others offer access to commercial real estate investment properties, usually reserved exclusively in the private market, to individual investors. Many of these platforms have tools and resources for learning and a professional network to connect with other real estate investment professionals.
The infrastructure today that allows for real estate investing education "makes it a lot easier to make good choices and avoid making mistakes," Getty says.
Risks and Rewards of Commercial Real Estate Investing
Every investment carries with it some kind of risk, and commercial real estate is no different.
While the economy has been in recovery mode, the impact of the pandemic has affected some commercial properties more than others during this past year. Vacancy levels rose for properties, including retail, office spaces and apartments, while other properties such as industrial and data centers have performed better.
But Steven Buss, founder of Likewise Partners in Minneapolis, says long-term contractual leases are an important characteristic of the commercial real estate business.
When a commercial property has a long-term contractual lease, you don't have to worry about near-term market exposures.
"It's an insulator from economic volatility," Buss says.
"The longer-term they are, typically that means a higher value for the property because you have the certainty of fixed income, and that creates a higher valuation in the marketplace," Buss says.
Since the value of real estate deteriorates over time, there is a tax code that allows commercial property owners to depreciate the value of the property and receive an annual income tax deduction. This allows the investor or property owner to be compensated for property improvements needed to address wear and tear as the property is used.
Depreciation allows you to hold on to more of your money by saving it from taxes. For nonresidential properties, the IRS allows depreciation over 39 years, which can add up to significant benefits over time.
Another reward that comes with commercial real estate investing is through the 1031 exchange, a tax instrument that allows capital gains to be deferred. When you sell an investment, you usually have to pay capital gains tax, but a 1031 exchange allows real estate investors to hold off on capital gains tax when selling a property to provide more capital when buying another investment property.
Should You Invest in Commercial Real Estate Now?
The economic environment is poised well for commercial real estate in 2021, experts say.
Getty points to a series of factors that make the current economic climate ideal to start investing in commercial real estate, particularly historically low interest rates.
"With relatively small amounts of money, let's say $25,000 to $50,000, you can get a lender to advance money to you and you can buy a $200,000 (property) with a small down payment. The power of leverage with low interest money is awesome because you use other people's money to help compound your money," he says.
Investors who choose to take advantage of today's low interest rate environment can lock in an interest rate on a commercial mortgage loan for a while.
You may be able to take "interest rate" risk off the table for some time, Buss says. This makes low interest rates a "return enhancer," boosting your after-debt returns.
"When you're borrowing 60% or 70% of the purchase price, interest rates are at historical lows, and you can lock those interest rates in for five to 10 years, that helps your after-debt returns," Buss says.
Other factors Getty observes that point to a positive time to invest in real estate include stable stock market performance, great amounts of stimulus into the economy and the investment infrastructure today that supports widespread access to data.
One strong emerging class of commercial real estate: industrial. Bartel says this sector has been growing during the past three to five years due to the "rise of digital delivery." This includes commercial real estate such as storage facilities, warehouses or showrooms.
The segment that suffered the most because of the pandemic: retail space. Although Bartel says there are still some growth opportunities in this area.
"When you have space that can be leased at a lower rate, well-located rather than having to leasehold informal industrial areas for distribution centers, we're going to see opportunities for retail, shopping centers and strip malls being used for distribution centers," Bartel says. This trend of pop-up distribution centers will continue in locations across the country, he says.
Knowing the trends occurring in commercial real estate markets is important when identifying investment opportunities.
Commercial real estate investing has unique advantages but, like any investment, it has its pros and cons.
Whether you're a beginner in this real estate market or a seasoned investor, the same rules of due diligence and principles of sound investing should be top of mind.