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Investing in Commercial Real Estate Property: A 5-step Guide

NNN leases Landlords and tenants responsibilities

Commercial real estate (CRE) investing can be highly lucrative for those who take the time to learn the basics.

With the right property, investing strategy, and team, commercial real estate offers attractive returns compared to other asset classes. However, CRE investing is also a complex activity with many nuances that must be understood.

Like any investment, thorough research and due diligence are required to succeed. This article overviews commercial real estate as an asset class and outlines a 5-step process to begin as a beginner.

Whether you’re looking to invest in your first commercial property or want to expand an existing portfolio, follow these essential steps to increase the odds of reaping some attractive returns.

What is Commercial Real Estate (CRE)?

Commercial real estate (CRE) refers to any property used for business purposes rather than residential living. This includes office buildings, industrial warehouses, retail stores, mixed-use developments, hotels, multifamily apartment buildings with 5+ units, and more.

In the same way investors choose to invest in residential real estate, CRE properties are purchased by investors seeking to increase their wealth, protect themselves from inflation, or generate income.

CRE offers some key advantages as an investment asset class, including the following:

Higher returns

Commercial properties generally earn higher rents per square foot compared to residential properties. Returns between 8-12% are expected for well-run CRE assets.

Longer leases

Commercial tenants sign longer initial lease terms of 3-10+ years versus one year for residential. This provides more reliable income over time.

Limited maintenance

Tenants handle most interior maintenance as part of triple net (NNN) leases, reducing landlord responsibilities.

Tax advantages

Commercial real estate benefits from tax deductions for depreciation and other write-offs.

Economies of scale

More significant CRE properties efficiently serve multiple tenants, increasing potential income.

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Inflation hedge

Rents and property values tend to rise with inflation over the long term.

Investors can specialize in each property type based on deal size, condition, location, and tenants. As with real estate, the adage “location, location, location” rings true. But CRE investors must also consider property usage, demand drivers, and infrastructure.

Breaking down Commercial Real estate (CRE) Investing

When exploring CRE as a potentially investable asset, you must understand the different property types, classes, and investment strategies available. Here’s an overview of some key concepts to consider and familiarize yourself with:

Property Types

The most common CRE properties include the following:

Office

From small professional office suites to downtown skyscrapers. Class A buildings are newer and more prestigious. Class Bs are older but functional. Class Cs are distressed or in need of renovation.

Retail

Retail CRE ranges from stand-alone locations to large shopping malls. These typical examples of properties within this category are grocery stores, restaurants, shopping centers, and mixed-use retail spaces.

Industrial

Warehouses, manufacturing plants, and distribution centers. Size and features vary by tenant needs, such as height, power, loading docks, etc.

Multifamily

Apartment complexes from garden-style to high-rises. Any 5+ unit qualifies as commercial.

Hospitality

Hotels, motels, resorts, assisted living, and recreational facilities like golf courses belong in this category.

Specialty

Any unique building, like gas stations, car washes, self-storage, funeral homes, and other venues, may only be used for a specific purpose.

Investment Strategies

CRE investors use different strategies based on their goals, time horizon, and risk tolerance. Here’s a summary of the most common ones:

Core

The core investment strategy is the lowest risk. It is the purchase of established properties like Class A office buildings or anchored retail. This strategy provides reliable income with less hands-on work.

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Value-add

Adding value is a moderate risk. It involves purchasing and operating older Class B/C properties purchased below market value. Investors typically perform renovations to increase rental income.

Opportunistic

Opportunistic is considered the highest risk. It focuses on distressed or vacant properties in need of repositioning. Requires major upgrades and lease-up. The amount that needs to be invested is typically high, and returns can be volatile.

Development

Development is the construction of new buildings or redeveloping sites to turn them into new properties. This strategy offers the highest reward, but it can be very capital-intensive.

Income

This is the income strategy when investors purchase properties that generate steady cash streams and slowly appreciate.

Appreciation

Target properties with upside value through renovations, repositioning, or market shifts.

Tax advantages

Seek benefits like depreciation to shelter taxes on other income.

Owner-occupied

The owner-occupied strategy is when investors also operate their business from the property.

The best strategy aligns with your investment goals, experience, desired role, and risk tolerance. Many investors evolve across multiple systems over time.

Building a team

Finally, having a network of advisors you can rely on to make deals is essential. This network may include the following professionals and organizations:

  • A real estate agent or realtor
  • Commercial mortgage brokerage firm
  • Attorney or property conveyancer
  • Accountant and Tax expert
  • Property manager or leasing agent

5-Step Guide to Invest in Commercial Real Estate (CRE)

Succeeding in commercial real estate investing requires following a systematic approach. Here is a 5-step guide for beginners:

Step 1 – Set Investment Goals and Criteria

Your investment goals will be driven by what you can borrow. Define how much capital you have using your commercial mortgage brokerage firm calculator. Then, work out the type and class of property you will target, preferred location(s), ideal tenants, desired deal size, acceptable timeframe, target returns, and role in operations.

Set detailed investment criteria to filter out potential deals. Some metrics to focus on include the minimum capitalization rate, monthly cash flow, condition, location, etc. Stick to these standards even if tempted by other options.

Step 2 – Build Your CRE Knowledge and Team

Learn the critical differences between residential and commercial real estate. Study your target market deeply. Assemble a team of specialists, including a commercial real estate broker, estate attorney, accountant, contractor, and property manager. Lean on these experts to supplement your knowledge gaps when starting.

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Step 3 – Find and Vet Deals

Leverage your broker’s relationships to source off-market listings. Scrutinize deals that meet your criteria. Run detailed financial analyses on viability. Thoroughly tour properties and ask probing questions. Request documents like rent rolls, leases, and operating histories. Don’t let emotions or fear of missing out sway your decisions.

Step 4 – Make an Offer and Perform Due Diligence

Submit a competitive offer with contingencies. Negotiate deal terms and price if needed. Once under contract, verify everything about the property, including its market feasibility study, environmental assessment, title search, engineering inspections, and zoning review. Set aside reserves for unexpected expenses. Be ready to walk away if some deal-breakers show up during the due diligence process.

Step 5 – Close and Operate the Asset

Finalize financing and syndication (if applicable). Conduct pre-closing walkthroughs. Obtain insurance and any licenses. Sign leases and collect the first month’s rent. Transfer utilities and implement management. Continuously monitor financials and tenant relations. Maintain reserves for maintenance and vacancies. Create value through renovations or lease rollovers over time.

Bottom Line

Commercial real estate investing provides an opportunity that can yield attractive returns. However, success requires education, resources, and gradual implementation. Beginner investors should partner with experienced mentors and brokers when getting started.

Arm yourself with knowledge of property types, metrics, and regulations within your specialized market. Search for deals that meet your detailed criteria rather than compromising on less ideal acquisitions.