As explained in this article— “What is Commercial Real Estate?”—commercial real estate is property owned with the purpose of producing income.
Commercial real estate investing generally involves greater start-up costs than residential real estate (such as buying a house for the purpose of renovating and reselling it) because the prices of commercial properties are higher. Also in contrast to residential real estate, the usable square footage of a commercial real estate property affects its income potential: more square footage means more potential income.
The process of investing in commercial real estate has some similarities to the process of purchasing a single family home for the purposes of earning rental income. For example, an investor must decide whether they want to invest in a real estate investment trust (a “REIT”) that has a portfolio of commercial properties, or whether they want to purchase commercial real estate on the private market. In the former option, the properties are managed by the real estate company, and the investor receives dividend payouts from the rent collected on the real estate. In the latter, the investor is the owner of the commercial real estate property and is responsible for managing it.
Purchasing commercial real estate through an REIT is simple: the investor buys it in the same way that they would buy a stock—they make a phone call to their broker, place the order, and pay the commission. However, whether the investor chooses a public REIT or a property on the private market, it is important to understand the types of commercial real estate on the market.
Learn about the Different Commercial Real Estate Categories
To review, the major categories of commercial real estate are: retail, offices, multi-family housing, industrial, hotels, and special use properties. Each category has various pros and cons. For example, an investor who is interested in purchasing industrial real estate should be aware that heavy manufacturing facilities require extensive renovation in order to be suitable for new tenants.
Assemble a Team of Experts
An early step in the process of making real estate investments is generally to hire a team of experts to assist in the purchasing process. These individuals can include:
- Accountant – To help the investor figure out what their business can afford, and analyze the operating budget and tax benefits.
- Attorney – Will help complete the real estate transaction by negotiating on the investor’s behalf with the lender and seller.
- Commercial broker – A real estate broker that will assist the investor in identifying potential affordable properties.
- Mortgage broker – Will help the investor pick the best financing options.
Find and Select the Right Property
With the assistance of their team, the investor can begin looking for suitable commercial real estate property. Example factors to consider when searching are: location, physical condition of the structure, ease of access and parking, zoning laws that may restrict alterations, allowable uses, and space available for expansion or leasing.
The investor should visit and evaluate numerous properties. Locating an array of commercial real estate investment opportunities requires networking with various dealers and real estate brokers, and reaching out to bankers, attorneys and mortgage brokers.
Conduct Due Diligence on the Property
Once a commercial real estate investor finds a prospective property, the next step is to research the property to see whether it aligns with their investment objectives. This process includes having an appraisal performed, along with reports on the physical and environmental conditions of the property. The investor may contact a title company to check whether the property has had any insurance claims filed against it. Adjacent properties should also be considered, as they have the potential to affect the investor’s prospective property.
Investors should also know the key metrics for assessing a piece of commercial real estate, including the real estate’s net operating income, the cap rate, and cash on cash return. An accountant can assist in evaluating the property’s financials and advising the investor on the real estate’s investment potential.
Select a Financing Option and Make the Purchase
If the commercial real estate property passes the due diligence process, and a selling price has been negotiated, the investor should decide how they will finance their purchase – will they pay cash, take out a commercial loan, etc.? An accountant and attorney are crucial at this stage, as they will ensure that all contracts are structured correctly and optimized for the investor’s benefit.
The sales agreement will cover matters such as: the names of the parties, the description of the property and its address, the sale price, the closing date, specifics on how the contract can be terminated, the type of deed that will be delivered when the deal is closed, and more. It is also important for the investor to have an up-to-date business plan ready to execute as soon as the purchase is made, so they can begin producing income as soon as possible after they close their commercial real estate deal.