If you’re an investor who owns a residential real estate, you may already be tired of few things. Overpriced properties, fierce competition and the amount of time are a time-consuming task. You might have already considered investing in a commercial real estate.
Many investors who start off with residential real estate eventually graduate to the commercial real estate for a number of reasons.
Less Work
The upkeep and management of residential real estate can be relatively time-consuming. Between routine and emergency maintenance, collecting rent, handling tenant complaints, filling vacancies, and so on, the time spent on handling properties can be a lot more than you planned on.
In fact, if you divide your profits by the number of hours spent, you are very likely to discover that the returns aren’t as high as they seem.
Commercial real estate properties, on the other hand, are likely managed by a property manager. He is responsible for handling all aspects of the property – leaving you free to do what you like. Because the margins are higher on commercial property, you can afford (and are in fact expected) to hire an experienced property manager.
Attractive Returns
Commercial real estate returns equal or more than alternative investments such as stocks, bonds, or other commodities. For example, the average return for a triple net property is about 6% – much higher than the average return of a typical stock. And while experts say those investing in stocks should aim for a 6-8% return, the average investor realizes returns of about 3.7% – no matter what the investment vehicle.
On the other hand, the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index reported an annual return of 12.7% in 2015 – far more than the S&P 500, Dow 30 and Russell 2000.
Over the longer term, the NCREIF Index reports that the average annual return for individual commercial real estate properties in the private market is 8.8% over the last 15 years. That is 200 basis points above the average performance of the S&P during the same time.
Cash Flow
Investors purchasing commercial real estate make sure the investment pays for itself. In other words, the cash flow generated by the tenants must be high enough to cover the expenses of owning and maintaining the property.
In general, buying a commercial real estate property is about the numbers – how to make sure a particular property meets your investment goal. It does not involve the emotion that tends to creep into residential deals. If the due diligence period shows the property is a good deal, then the investor is ready to go on to the next step. If not, then they head on to a better deal.
Plus, certain types of properties, by their very nature, are less “expensive” to own. Triple net lease properties hold the tenant responsible for all expenses. And because the lifeblood of a business depends heavily on how it looks, commercial tenants maintain properties in good condition.
Investors who choose to loan money to other investors also experience a steady cash flow, as dividends for investment are distributed on a monthly, quarterly, or annual basis.
Depreciation
According to the IRS, commercial real estate properties may deduct the cost of depreciation from tax returns. Deducting depreciation, which is the amount of money lost from the decrease in value of a property over time,
can result in a higher after-tax yield.
Principal Paydown
In property pay down, the rent paid by the tenants allows the owner to reduce the principal amount of the loan is fully amortizing loans.
Each month tenants pay a specific amount which can be used not just to pay the mortgage, but to reduce outstanding mortgage debt. This, in turn, reduces the monthly payment, increasing cash flow and thereby reducing the principal amount even further. This amount of money also reduces risk, making commercial real estate properties a smart choice for investors seeking a way to use leverage to increase returns.
Rental Yields
Rental yields for a commercial real estate property are higher than the same amount of space for a residential property. That’s because the value of a commercial property is tied to the tenants. Better tenants, more foot traffic in the area add up to a higher-performing property. In retail, that can translate directly to profit as the landlord of a retail property receives a percentage of a retail tenant’s profits.
If the property is a triple net, then the investor won’t have to worry about vacancies, which tend to be longer in commercial real estate: leases are often 30 years or more. It’s also becoming more common for a well-known business to sell their property in order to free up cash for improvements or new ventures. A provision in the contract allows the business to lease back the property, which ends up being a win-win for both properties.
How To Get Started
Before you get involved in commercial real estate, you need to sit down and decide what your investment goals are. Are you looking to diversify your portfolio? Are you looking for a way to invest your money safely, because you are planning on retiring soon? Or are you willing to invest in riskier projects?
You as an investor may find yourself unable to get an additional residential property. The reason could be because you have “maxed out” on the amount of money a bank can lend them, or because your portfolio is outside of what you normally work with. One more reason why you will find better prospects in the commercial real estate.
Lenders in CRE look much less on the buyer’s portfolio and more on whether or not the property performs well. If it does, in fact, show good returns, lenders are usually willing to consider your request.
Be Creative
There are fewer properties available for sale than residential, and because of that – and the costs involved – you will need to be creative when considering a particular property.
For example, a CRE property may have been in use for one particular purpose, but if you think creatively and look at the numbers, you might be able to find an alternative, more profitable purpose instead.
Of course, you’ll need to be well-versed not only with the ins-and-outs of a commercial real estate, but you’ll also need to have in-depth knowledge of the market.
Fortunately, an experienced broker can help you with both, guiding you to the best property type for your investment goals.
