If you’re considering adding commercial real estate to your investment portfolio, look no further – this is the article for you. Here, we’ll cover everything you need to know about investing in commercial real estate, from why it’s a smart move to how to get started.
We’ll also provide tips for investing in specific commercial properties, like office buildings and retail space. So whether you’re a first-time investor or a seasoned pro, this article has everything you need to know about commercial real estate investing.
Table of Contents
- Why You Should Consider Investing in Commercial Real Estate
- How to Get Started Investing in Commercial Real Estate
- Financing Commercial Real Estate
- Investing in REITs and What You Need to Know
- Tips for Investing in Multifamily Properties
- What to Know About Investing in Office Buildings
- Tips for Investing in Retail Properties
- What to Know About Investing in Industrial
- What to Know About Investing in Self Storage
Why You Should Consider Investing in Commercial Real Estate
When people think about real estate investing, they often think of buying a house or a condo. However, other great opportunities exist, particularly in commercial real estate.
If you’re considering investing in real estate, then you should definitely take a look at commercial properties. Here are some reasons why commercial real estate could be an excellent addition to your portfolio.
Generate Rental Income from Commercial Properties
Investors who purchase commercial real estate can generate rental income in a few different ways. One of the most common is leasing space to tenants. Owners can lease on a long-term basis, such as with an office building or retail store, or a short-term basis, such as with a self-storage facility.
Another way to generate income from commercial properties is through parking and concierge services. Investors can significantly increase the revenue generated from their commercial property by charging for parking or offering valet services.
Finally, investors can also structure a commercial lease with a percentage-based rent. This means the tenant will pay a base rent plus a percentage of their sales or revenues. This type of lease can be especially beneficial for properties located in high-traffic areas.
By understanding these different strategies, investors can maximize the income generated from their commercial property portfolio.
Commercial Real Estate Can Appreciate in Value Over Time
Investing in commercial real estate is a viable avenue to build long-term wealth. While the stock market is often volatile, commercial real estate values tend to appreciate steadily over time. Commercial real estate frequently outperforms the stock market regarding return on investment. This appreciation can hedge against inflation since property values usually rise along with the cost of living.
As a commercial landlord, you may be able to shift the costs of inflation to your tenants through CAM charges (common area maintenance fees) or by using a NNN lease (triple net lease) where the tenant is responsible for paying a base rent, plus maintenance, insurance, and property taxes.
These lease types also allow you to increase your rent periodically to keep up with the cost of living. As a result, investing in commercial real estate can be a great way to protect your wealth from inflation.
Tax Breaks When You Invest in Commercial Real Estate
As an investor, you’re likely always looking for ways to minimize your tax bill. When it comes to commercial real estate, there are several tax breaks that you may capitalize on.
One way to reduce your taxes is by deducting your operating expenses. These include property insurance, repairs and maintenance, utilities, and property management fees. By deducting these expenses, you can reduce your taxable net income.
You can also deduct mortgage interest on commercial properties, a significant benefit dramatically reducing your taxable income. In addition, you can also use depreciation to reduce your pre-tax income. Depreciation is a non-cash expense that allows you to recover the cost of your commercial property over time.
Finally, if you sell your commercial property, you can defer paying capital gains tax by doing a 1031 exchange. This allows you to reinvest the proceeds from the sale of your property into another similar property. As long as you adhere to the rules, you can indefinitely delay paying taxes on the sale.
By taking advantage of these tax breaks, you can save significant money on your commercial real estate investment.
Variety of Financing Options Available for Commercial Real Estate Investors
There are a variety of financing options available for commercial real estate investors. The most common type of financing is through a bank loan. However, there are also several other options, such as private loans, hard money loans, and government-backed loans.
- Bank loans are the most common type of financing for commercial real estate. They typically have the lowest interest rates and most extended repayment terms. However, they can be challenging to qualify for if you don’t have a strong credit history or considerable assets.
- Private loans are another option for financing your commercial real estate investment. Wealthy individuals or companies typically provide these loans. They often have higher interest rates than bank loans but can be easier to qualify for.
- Hard money loans are another option, though they are typically a last resort. These loans have very high-interest rates and short repayment terms. They are often used by investors who are flipping properties or who don’t have the time to wait for a traditional loan to be approved.
- Government-backed SBA loans are another possibility, though they are typically only available to certain types of businesses. These loans often have favorable interest rates and terms.
There are many different financing options available for commercial real estate investors. The best choice for you will depend on your circumstances. Talk to a financial advisor to determine which option is right for you.
Diversify Your Portfolio with Commercial Real Estate
When it comes to investing, one of the smartest things you can do is diversify your portfolio. Including commercial real estate in your investment mix can benefit you in many ways.
First, commercial real estate tends to be less volatile than other investments, providing a more stable source of income. Second, commercial real estate can provide significant tax breaks, which can help to boost your overall returns. Finally, commercial real estate can dynamically protect against inflation, as property values tend to go up when the cost of living rises.
Including commercial real estate in your portfolio can reap these benefits and more. So, if you want to add some stability and potential upside to your investment portfolio, consider diversifying with commercial real estate.
How to Get Started Investing in Commercial Real Estate
This beginner’s guide to commercial real estate investing will tell you what you need to know to start investing.
REITs for Hands-Off Commercial Real Estate Investing
Real Estate Investment Trusts, or REITs, are the simplest way to start investing in commercial real estate. You don’t need to buy an expensive commercial building. Instead, you invest the amount you want in a trust, and the trust pools your money with other investors to make commercial real estate investments and generate passive income.
REITs pay no corporate tax on their profits (unlike publicly traded companies) as long as they earn at least 75% of their income from real estate and pay at least 90% of their taxable income to shareholders.
REITs can invest in apartment buildings, offices, hotels, data centers, self-storage facilities, healthcare properties, and more. They might hold rentals or even fix-and-flip houses. The main characteristic of REITs is that the investors don’t actively participate.
- You don’t have to understand real estate or property management. Experts purchase and sell properties, manage rentals, and deal with repairs and maintenance on your and your fellow investors’ behalf.
- It’s easier to limit losses. You’ll never have to put up additional money after you make your initial investment. The trust spreads your investment across diverse properties, so any bad luck that can befall any single investment property (toxic mold, local economy, zoning changes, etc.) won’t wipe you out.
- REITs are highly liquid. You can sell them immediately at any time for their current total market value. While the rise of CRE tech makes buying and selling faster, it’s still more challenging to try and time the market with an office building.
- Most REITs aim to generate stable returns and steady income. They won’t set the world on fire but won’t keep you up at night.
REITs afford you many advantages of rental property ownership without owning the properties yourself. Due to their economies of scale, most REITs pay above-average dividends and generate impressive property appreciation.
Purchasing and Managing Commercial Real Estate
If you want more control and potentially higher (sometimes much higher!) returns, you can invest in commercial real estate yourself. An experienced commercial real estate agent and property manager can alleviate the burden and take care of the tasks you can’t or don’t want to.
Annual rental income for commercial properties ranges between 6% and 12% of the purchase price. That’s in addition to any property appreciation you realize. According to the Commercial Property Price Index (CPPI), for example, industrial property prices have increased 18% over the past 12 months. If you earn 12% annual rent and 4-5% yearly appreciation, that’s a healthy 17% annual return.
Types of Commercial Property
There are several main commercial property types, and they don’t all offer the same returns. According to the most recent National Commercial Real Estate Investor Fiduciary’s Property Index, quarterly returns (Q2 2022) for commercial sectors were:
- Industrial: 5.86%
- Office: 0.58%
- Apartment: 3.86%
- Hotel: 1.80%
- Retail: 1.68%
The quarterly return for unleveraged core real estate held by institutional investors was 3.23%, consisting of 0.97% from income and 2.26% from appreciation. Properties with debt financing have a leveraged total quarterly return of 4.06%. Besides the above-referenced property types, you can choose alternatives such as self-storage, medical, elder care, land, parking, and event space.
Different property types also vary in cost and respond to ongoing market changes, so research into historical market performance is essential. If you have unique expertise in a specific industry, you might have an advantage over less-informed investors.
What Does a Commercial Real Estate Agent Do?
To purchase commercial real estate, you’ll want to rely on the advice and assistance of a commercial real estate agent. The seller’s agent represents the interests of the seller. You’ll want your own agent to look after your interests as a buyer. (Both agents split a real estate commission paid by the seller).
A commercial real estate agent’s job is more complicated than a residential real estate agent’s because a commercial real estate investment is a business with many moving parts.
Here are the services a commercial real estate agent may provide for you:
- Evaluate property using local comparables or “comps” to determine fair market values
- Provide financial information and analysis
- Show and explain the features of buildings
- Discuss the costs of maintaining facilities and possible renovations
- Determine the best method of purchase and review financials
- Ensure all paperwork is completed properly
- Ensure the purchase is legal and binding
- Identify, analyze, and prepare redevelopment plans
- Have all properties inspected thoroughly and identify possible repairs
- Help negotiate property prices and settlement details
- Work with commercial attorneys, loan officers, and agencies to complete the purchase
- Help arrange financing
Unless you are very comfortable with financing and real estate, buying property without an experienced commercial real estate agent’s assistance is probably a big mistake. If you don’t understand these formulas, don’t even think about going it alone:
- Net Operating Income (NOI): Revenue minus costs, excluding debt service and depreciation. Operating costs typically include insurance, property management fees, utilities, repairs and maintenance, and property tax.
- Cap Rate: Short for “capitalization rate,” this percentage equals net operating income divided by purchase price.
- Cash on Cash: Cash on cash tells you how quickly you’ll recoup your initial out-of-pocket investment. To calculate cash on cash return, divide the cash income earned after paying all operating expenses (including any debt service) by the total money invested.
Your agent should help you calculate these figures and determine which properties make the best investments.
How Much Work Is Commercial Property Investing?
Here are some important points when deciding if you want to handle your properties entirely or outsource some or all of the work:
- Business owners renting commercial space have a vested interest in maintaining their premises because their business will suffer if they don’t. This is like having them on your management team, taking on a chunk of the workload.
- Most businesses close at night and have an alarm monitoring service so that if anything does happen at night, the alarm company notifies the authorities. Less work for you.
- Commercial property can be easier to value because you can see the seller’s income statement. A knowledgeable broker should establish a price that delivers your area’s prevailing return (known as the “cap rate”).
- Commercial properties often come with “triple net” leases, where the tenant is responsible for all property maintenance and expenses, including real estate taxes.
- If you have many properties or buy apartment buildings, you’ll have to invest time and money (or hire a property manager). You may have to administer multiple leases, calculate annual CAM (Common Area Maintenance) adjustment costs that tenants are responsible for, as well as account for maintenance and repair, liability, and public safety.
- It’s risky to DIY your property management unless you’re licensed to do the tasks you take on because of the liability potential. Include applicable property management/maintenance costs when determining what you’ll pay for a commercial investment property. Property management typically costs 5% to 10% of rent revenues. It’s also wise to outsource the maintenance and repair.
- Commercial properties usually have more public visitors, have more public visitors, creating additional damage, injury, and theft opportunities. Look into insurance coverage and cost when evaluating a commercial property.
If you lack commercial property management experience, you may wish to initially hire a property manager, even if you eventually want to manage your buildings yourself.
What Does a Property Manager Do?
If the list above appears daunting, relax. You can bring in professional help. Here are the services (when applicable) your commercial property management fees can buy:
- Establish and maintain a maintenance schedule
- Establish and implement housekeeping programs
- Supervise all vendors
- Supervise repairs and alterations
- Analyze service contracts to determine which providers are the most cost-effective
- Collect all rents, additional charges, and miscellaneous income
- Review existing leases and prepare new leases
- Provide monthly financial reports
- Pay real estate and personal property tax, improvement assessments, and other charges
- Prepare tenant analysis for retail spaces
- Make all mortgage, ground lease, and promissory note payments and comply with mortgage documents
- Enforce leases per their terms and notify you of any defaults
- Distribute income to you at your request
The service you require from a property manager depends on the number of tenants and leases and the operation you’re running. If you own a single building with one industrial tenant and a triple-net lease, that’s much less work than an apartment complex with 100 residential tenants and leases.
Financing Commercial Real Estate
There are many ways to finance commercial real estate, depending on the type of building and what you’re doing with it. Your agent should be able to point you in the right direction for appropriate loans.
Small Business Administration (SBA) 7(a) and 504 Loans
SBA 7(a) loans and SBA 504 loans are business loans backed by the Small Business Administration (SBA). SBA 7(a) loans are the most common type of SBA loan used to purchase commercial properties up to $5 million. These loans typically request at least 10% down, a minimum credit score of 680, and at least three years in business. Interest rates range from 5% to 8.75%.
The property must be at least 51% owner-occupied, which means you can use it for your own business and rent to other tenants, as long as your space accounts for more than half of the total square footage.
SBA 504 Loans are similar to the 7(a) loan, except the 504 does not have a maximum loan amount.
Conventional Commercial Mortgage
Lenders typically require a 25% down payment minimum in exchange for a fixed-rate mortgage ranging from 5 to 30 years (most commonly between 5 and 10 years). Excellent credit is required, but the interest rates are among the lowest for commercial real estate financing.
These loans are appropriate for properties in good condition with established income.
Commercial Bridge Loan
A commercial bridge loan is a 6-to-12 month loan you might use if you need to improve or lease your property before you can refinance it into a long-term loan with better terms.
Because they have short terms, bridge loans come with higher interest rates and fees. Expect to pay an interest rate that’s .5% to 2% higher than a traditional, fixed-rate mortgage.
Hard Money Loan
Hard money loans are an alternative form of capital provided outside traditional lending channels, by individuals or companies. You might use one if you need to move very quickly to purchase a property, but they have concise terms and high fees.
Hard money lenders care primarily about the property value and less about your creditworthiness. Hard money loans are also called private mortgages and don’t have the same consumer protections as other products. Expect to pay interest rates ranging between 10% and 20%.
How Much Involvement? It’s Your Choice
Real estate investment can be as involved and complicated as you want to make it. There’s a whole spectrum of involvement, risk, and potential return, from entirely passive REITs to 100% owner-selected and -managed buildings and everything in between.
A knowledgeable broker and proficient property manager are probably worth every penny and a great way to learn without being burned if you’re just getting started.
Investing in REITs and What You Need to Know
Nearly 145 million Americans, plus countless institutional investors and family offices, invest in REITs – either directly, through REIT mutual funds, or via exchange-traded funds (REIT ETFs). REIT stocks have historically delivered competitive returns, reliable dividend income, and long-term capital appreciation for property investment and commercial real estate investors.
Here’s a more detailed breakdown of how REIT stocks work, the pros and cons of REITs, and some of the best REIT stocks to invest in this year.
What are REIT stocks?
A real estate investment trust (REIT) is an income property organization that acquires and manages income-producing commercial real estate.
REITs invest in commercial real estate asset classes like retail real estate, office buildings, apartments and multifamily property, leisure and hospitality assets, industrial properties, and special purpose real estate investments such as self-storage or data centers.
The largest publicly traded REITs have proven performance track records and provide investors with regular dividend payments. Those are merely two reasons why real estate investment advisors recommend REITs as promising passive real estate investments.
How a REIT Works
Unlike real estate companies that develop real estate for resale, a REIT buys and manages its property as part of its own investment portfolio. The U.S. government established REITs in 1960 to provide large and small investors easy access to income-producing real estate.
To qualify as a REIT, companies must meet the following conditions:
- Invest at least 75% of total assets in real estate assets and cash.
- Derive at least 75% of gross income from real estate-related sources, such as rents and interest on mortgages.
- 90% or more of taxable income must be distributed to shareholders annually, usually as dividends.
- Have fully transferable shares.
- Have a minimum of 100 shareholders after the first year as a REIT.
- Have no more than 50% of shares held by five or fewer individuals during the last half of the taxable year.
Common Types of REITs
REITs generally fall into one of three main categories, along with some often-overlooked special-purpose asset classes:
Common REIT types
- Equity REITs own the underlying real estate and act as a landlord, collecting rents and managing and maintaining the property.
- Mortgage REITs own the debt securities secured by the property; while they may be riskier than equity REITs, they normally pay higher dividends to investors.
- Hybrid REITs are a combination of equity and mortgage REITs and can potentially provide investors with better risk-adjusted returns.
Special purpose REITs
- Industrial REITs include warehouses, cold storage, and distribution centers.
- Data center REITs include buildings that house switches, storage systems, and routers.
- Self-storage REITs own and operate self-storage facilities.
- Lodging and hospitality REITs own, acquire, and manage hotels, luxury resorts, and business-class hotels.
- Timberland REITs invest in forest land assets and generate income by harvesting timber and related products.
- Infrastructure REITs property types include energy pipelines, telecommunications towers, fiber cables, and wireless infrastructure.
Pros and Cons of REIT Stocks
As with any commercial real estate investment, there are benefits and drawbacks to REIT stocks that investors should be aware of.
Benefits of REIT stocks
- Recurring dividends with 90% of taxable income distributed to shareholders.
- REITs pay no corporate taxes, maximizing dividend payments to investors.
- Access to high-quality commercial real estate, including shopping centers, iconic office buildings, and single-family home developments.
- Very liquid because REITs trade on the major stock exchanges and can easily be bought and sold online.
- Portfolio diversification geographically and by asset classes protects capital through economic ups and downs.
- Higher potential returns due to regular dividend distributions and appreciation of asset values over the long term.
Drawbacks of REIT stocks
- Dividends distributed to shareholders are taxed as ordinary income unless REIT stocks are held in an IRA.
- Interest rate changes can affect the level of debt service in a REIT, as with other types of real estate investments.
- REITs may have lower growth and capital appreciation because most profits are paid out to investors as dividends.
- Some asset classes held by REITs may have higher potential property-specific risk than others.
- REITs are ideal as long-term buy-and-hold investments that may not suit the needs of every real estate investor.
Things to Look For in a REIT
Before buying a REIT stock, there are several things an investor should keep in mind:
- Best REITs provide consistent high dividends along with long-term capital appreciation.
- REITs are highly liquid, with stocks trading on all major exchanges instead of directly owning illiquid real estate.
- Looking at a REIT’s funds from operations is a better way to assess the true value of the REIT because depreciation expense can understate the actual value of the assets held.
- Search for REITs with a historical track record of success through all stages of the economic cycle.
- Look for REITs that own quality property leased to stable regional or national tenants.
Best REIT Stocks for 2022
Kiplinger is an American publisher of business forecasts and personal finance advice. The company recently listed the 12 best REITs to own this year for real estate investors seeking diversification and more income than the market average:
|REIT||Symbol||Type||Market Value||Dividend Yield|
|National Retail Properties||NNN||Net lease REIT||$7.0 billion||5.3%|
|Essential Properties Realty Trust||EPRT||Sale-leaseback||$2.6 billion||5.3%|
|W.P. Carey||WPC||Single-tenant net lease||$15.6 billion||5.2%|
|Agree Realty||ADC||Net lease retail||$5.1 billion||4.1%|
|Digital Realty Trust||DLR||Data center||$36.2 billion||3.8%|
|Alexandria Real Estate Equities||ARE||Life science||$22.1 billion||3.5%|
|Camden Property Trust||CPT||Apartments||$13.4 billion||3.0%|
|American Tower||AMT||Communications||$109.0 billion||2.4%|
|Sun Communities||SUI||Manufactured housing||$18.8 billion||2.3%|
|Rexford Industrial Realty||REXR||Warehouse||$9.9 billion||2.2%|
REIT stocks offer something for every type of real estate investor, from high-quality commercial real estate assets to niche special purpose properties. Investing in REIT stocks is prudent, as it provides solid long-term performance, healthy and stable dividend yields, and portfolio diversification to its shareholders.
Tips for Investing in Multifamily Properties
Apartment buildings offer great benefits for commercial real estate investors due to their scale and potential for high returns. Demand for rentals is currently high because of a low-cost housing shortage in most American cities.
Owning a property with multiple units can be incredibly lucrative with the right financing. A report released in July 2022 revealed that the national median rent for a one-bedroom apartment is $1,450 and $1,750 for a two-bedroom. Multiplied by, say, 100 units, an investor could be making upwards of $1.7 million in gross rental income per year.
Multifamily properties, however, can carry a hefty price tag and aren’t necessarily the most straightforward purchase. That being said, not all apartments are ultra-expensive, and some buyers can find multifamily properties for little to no money down.
Finding a Multifamily Property
Before investors can start making money, they must find a property that matches their budget, goals, and needs.
Set your budget
Step one to buying an apartment building is setting your budget. In addition to setting aside money for a down payment, calculate how much you’re willing to spend on repairs, maintenance, and other associated costs, such as building security.
Use a realtor
Use a local realtor who specializes in helping investors find commercial real estate. These agents will have access to properties that have not yet hit the market because of their connections. They will be able to find properties that match your goals and budget.
Choose a market
Choosing the right market is hugely important in finding a property that will generate significant cash flow. Check if rental prices in the neighborhood you want to buy in have been increasing or decreasing in recent years. Determine if the property is in an area with job opportunities for tenants or near where you currently live (it’s easier to manage a property you can drive to rather than one out of state).
Pick the right financing
Another vital step to buying a multifamily property is choosing the right type of financing. Some options include:
- Commercial loans: Banks will offer lenders a traditional mortgage for properties with four units or less. For an apartment complex, however, you will need to get a commercial loan. These types of loans have different requirements than residential home loans and often require larger down payments.
- Find a partner (or several): Some investors may decide to pool their money together to purchase a multifamily property. By finding a partner or partners, an investor can buy a larger property, increasing their potential ROI and decreasing their risk.
- Find a hard money lender: If an investor does not qualify for a commercial loan (due to previous credit history or the property’s condition), they may consider finding a hard money lender to give them cash. Hard money loans have higher interest rates and shorter time frames than traditional loans.
- 1031 exchange: 1031 exchanges are named after section 1031 of the internal revenue code. The rule is triggered when a property’s sales price exceeds its purchase price, producing a profit or a “capital gain.” Capital gains are subject to taxes, but under a 1031 exchange, investors can defer these taxes. 1031 exchanges have strict rules and only work if an investor swaps one property for another property of equal or greater value. While this is not financing per se, it can help during the purchasing process and helps increase overall ROI.
Hire a real estate attorney
Commercial real estate transactions are much more complicated than residential transactions. Hiring a real estate attorney is always best when dealing with a complex transaction.
Although lawyers often range between $150 to $350 per hour, they will help develop contracts and agreements and carry added weight during negotiations. If the investment is a joint purchase, a lawyer can ensure the co-buyer agreement clarifies precisely how each party will hold the title. Many commonly encountered gray areas must be clarified in writing to protect both parties.
Owning a Multifamily Property
After buying the perfect investment property, the investment journey truly begins.
Maintenance & Upkeep
Owning an apartment complex is a huge responsibility, and maintenance will take a large piece out of the bottom line. It’s best to research the local region’s average rate of common renovations and repairs before buying. Renovations can include:
- Repainting the exterior and interiors
- Redoing the landscaping.
- Fixing the flooring
- Changing light fixtures
- Updating appliances
There will also be additional associate costs such as insurance, security, cleaning, property taxes, and more.
Attract quality tenants
Owners need to make sure their property has a wow factor. In addition to choosing the right location and maintaining the property’s appearance, there are several things investors can do to attract quality tenants. These include:
- Creating a well-written listing with high-quality photographs
- Installing amenities found in nearby popular communities
- Using digital tools for applications and leases
- Interviewing tenants and performing a background check before lease-signing
- Laying out clear rules and criteria for tenants before they move in
A real estate attorney or agent can help owners create and implement some of the items mentioned above. They also can offer references for contractors, insurance agencies, staffing offices, cleaning services, and more.
Keep residents happy
Owners and building managers need to listen to their tenants. Making necessary repairs promptly, using online tools for rent payments and amenity requests, and responding quickly to concerns are a few ways to keep residents happy. In the long run, ensuring the happiness of a property’s tenants will determine the popularity of a property and the quality of tenants it attracts.
Options for Passive Investors
For some investors, owning an apartment complex is perhaps out of budget or carries too much responsibility. However, they may still want to invest passively in commercial real estate.
One of the most popular ways to passively invest in commercial real estate is through a real estate investment trust (REIT). See above for a full guide on REITs.
Like REITs, crowdfunding platforms offer individuals the chance to invest in property without physically buying and managing it directly. Unlike REITs, crowdfunding platforms are not publicly traded on an exchange. Investors can choose the exact property they want to invest in and are paid through the profits a property earns (e.g., via rental income, flipping the property, etc.).
Whether an investor decides to own and manage an apartment complex or passively invest via REITs and crowdfunding apps, they should not be afraid to dive into the world of commercial real estate. With proper research and dedication to an investment, multifamily property owners have the potential to earn high ROI and quickly diversify their portfolios.
What to Know About Investing in Office Buildings
A recovering economy and more workers returning to the office are two factors generating renewed interest in office buildings for sale. Many investors looking for offices for sale are surprised to learn that office rent growth has been steadily increasing year-over-year despite the pandemic, while office-using employment is on the rise.
Why Investors Like Office Buildings
Buy-and-hold investors seeking stable cash flow, inflation protection, and depreciation benefits to reduce taxable net income often invest in office buildings.
Stable cash flows
Office building lease terms typically run for 5-10 years, providing office building investors with bond-like returns without the cost and inconvenience of annual tenant turnover. The cost of relocating a business from one office location to another can be prohibitive. An office building tenant often has a built-in incentive to renew the lease instead of looking for new office space for rent, making an office for sale an attractive investment.
Multiple lease structures
An office building for rent may offer gross, modified gross, or triple net (NNN) lease structures, each with distinct advantages, depending on an investor’s objectives. Office building leases can be written to protect the landlord from inflation by passing part or all of an office building’s operating expenses through to the tenant, in addition to annual base rent increases.
Assets like office buildings depreciate over 39 years, creating a tax shelter for real estate investors. For example, if the value of an office building (excluding the land) is $1 million, an investor can write off $25,641 in depreciation expense to reduce taxable net income. That’s why an office building for sale can provide potential depreciation tax shelter.
Office Building Investing Basics
Office buildings come in all shapes and sizes and exist in nearly every commercial real estate market in the US. According to Cushman & Wakefield, there are over 5.5 billion square feet of office space in the country, with more than 93 million square feet currently under construction.
Because the office building asset type is rather broad, investors often categorize office buildings by class, size, and tenant type or use:
Office buildings classes
- Class A: New or like-new “trophy properties” with the latest features and amenities, usually located in the central business district (CBD) of large urban areas, occupied by the best tenants.
- Class B: Slightly older office buildings well maintained and in good condition, often occupied by local or regional tenants. May offer the opportunity for value add improvements to generate additional rental income.
- Class C: Older office buildings requiring significant remodeling and updating, sometimes located in business areas that have lost their luster. Class C office buildings may be good candidates for repositioning into mixed-use projects or conversion into multifamily property.
Size of office buildings
Office buildings can range from one to over 100 stories in height. There are single-level or storefront office buildings, low-rise office properties of two to three floors, and mid-rise with up to 24 floors. High-rise office skyscrapers tower above, such as the 1,776-foot tall World Trade Center in New York City or the Willis Tower (formerly the Sears Tower) in Chicago with 1,450 feet of high-rise office space.
Office building types
Office building types are often characterized by the types of office tenants leasing the space. According to the Appraisal Institute, office buildings types include:
- Business park
- Condominium building with multiple office units
- Creative or office loft
- Medical office buildings
- General-purpose office properties
- Research and development
- Other office space such as mixed-use developments with office, retail, and residential space
Three Types of Office Building Leases
Office building leases generally come in three varieties:
- Gross leases benefit the tenant by including everything (such as utilities, janitorial, and maintenance) in the monthly rent and may be used by office landlords as short-term leasing solutions until a long-term tenant moves in.
- Modified gross leases are gross lease variations that pass through some operating expenses to the tenant, such as annual increases for common area maintenance, property or real estate tax, or insurance.
- Triple net leases (NNN) include a monthly base rent plus a pro-rata charge (based on the percentage of space a tenant occupies) for the three nets of maintenance, property tax, and insurance.
Office Building Investing Terms to Know
When analyzing a potential office building, there are several terms that buyers should know and understand to help make the right investment decision:
- Gross rent is the annual rent that landlords can collect if tenants fully lease the office building 100% of the time.
- Effective rent factors in potential rental income lost to vacancy when space is empty between tenants, additional rental income from amenities such as parking, and bad debt expense when a tenant does not pay the rent.
- Operating expense is the landlord’s ownership costs for common area maintenance (CAM), such as repairs, janitorial, landscaping, parking lot, utilities, property taxes, and insurance.
- Net operating income (NOI) subtracts operating expenses (excluding mortgage or debt service) from the effective rental income.
- Cap rate is a ratio that calculates the annual investment return of an office building by dividing the NOI by the office building value or sales price.
- Gross building area is the square footage of the office building and includes rentable office space plus common areas such as a lobby, mailroom, public restrooms, and elevator shafts.
- Gross leasing area (GLA) is the percentage of an office building’s rentable gross space. For example, an office building may have 100,000 square feet of gross space but only 75,000 of rentable space, limiting how much rental income the building may generate.
- Price per square foot is the value or sale price of the office building divided by the size of the office building. Office building investors take care to calculate the price per square foot of an office building based on the GLA or rentable square feet rather than the gross building area.
- Tenant improvements (TIs) are alterations made to customize an office suite for the needs of a specific tenant. The landlord and tenant may negotiate an office lease to include a certain amount of TIs as part of the monthly office rent, with any ‘extras’ such as upgraded flooring paid for by the tenant.
Potential Drawbacks to Investing in Office Buildings
Office lease rates and the demand for office space generally go up or down based on the strength of the local and national economy. During a recession, the need for office space can decline, and the rent tenants can afford to pay may decrease.
Office buildings with a large number of leases expiring soon may create unexpected vacancies for an investor if tenants choose not to renew their lease. Finally, older office buildings may be difficult to lease if floor plans are obsolete. That’s one reason old office buildings can be a better choice for investors seeking value add and repositioning opportunities.
The Bottom Line on Investing in Office
As the economy recovers, there are signs that the office market is also improving. CBRE analyzed the prospects of the largest US office markets based on key metrics, including positive net absorption, leasing activity, construction completions, increase in average gross asking rent, and growth of office-using jobs.
Based on the survey results, some major office markets to consider are Los Angeles, Boston, Atlanta, Seattle, Manhattan, and Dallas/Fort Worth.
Tips for Investing in Retail Properties
If you’re like most commercial real estate investors, you’re always on the lookout for new opportunities. And if you’re looking to invest in retail properties, you’re in luck. This type of investment is experiencing healthy growth in many markets right now.
However, while retail can be an attractive investment opportunity, it’s essential to understand the ins and outs of the retail market before making any decisions. Here are some tips for investing in retail properties.
Types of Retail Properties Available for Investment
When it comes to investing in retail property, there are a few different options available. Each has its pros and cons, so it’s important to carefully consider your goals and needs before making a decision.
One option is to invest in a shopping center. These tend to be large properties with multiple tenants, which can provide a steadier income stream than a single retail storefront. However, they also require more management and upkeep, and you may have less control over the individual businesses that lease space in the shopping center.
Another option is to invest in a strip mall. These are similar to shopping centers but smaller and with fewer tenants. They can be easier to manage than larger properties, but they may also be less profitable.
Finally, you could choose to invest in a single retail storefront. This gives you the most control over your property, but it also means that your income will be more dependent on the success of the business that leases the space.
Benefits of Investing in Retail Properties
You may wonder if investing in retail properties is a smart move for a commercial real estate investor. After all, the retail sector has been struggling in recent years, with many big-name brands shuttering stores and investing more heavily in online sales.
However, there are still plenty of reasons to consider investing in retail properties. For one thing, retail properties tend to be located in high-traffic areas, which can translate into higher rent rates. Additionally, retail tenants typically have longer lease terms than other types of tenants, providing more stability for landlords. And while online shopping may be on the rise, experts predict that brick-and-mortar stores will remain a vital part of the retail landscape for years to come.
Here are five benefits of investing in retail properties:
- Retail properties are typically located in high-traffic areas.
- Retail tenants typically have longer lease terms.
- Brick-and-mortar stores are predicted to remain a vital part of the retail landscape.
- Investing in retail properties can help diversify a portfolio.
- There are opportunities to add value to a retail property through renovations and re-tenanting.
Risks of Investing in Retail
If you’re thinking about investing in retail properties, there are a few risks to keep in mind. First of all, retail businesses can be susceptible to economic downturns. This means that if there’s a recession, tenants may have difficulty paying their rent, and you may end up with vacant units. Additionally, retail properties are often subject to high turnover rates. You may have to deal with the costs of re-leasing units on a regular basis.
To minimize these risks, do your homework before investing in retail property. Make sure you understand the local market and the demographics of the area where the property is located. Additionally, it’s important to choose tenants carefully and screen them thoroughly before signing a lease agreement. By taking these precautions, you can minimize the risks of investing in retail property and maximize your chances of success.
How to Choose the Right Retail Property for Investment
There are several best practices an investor should follow when choosing the best retail property to invest in:
- Consider the location
- Research the demographics of the area
- Look at the competition
- Analyze the foot traffic
- Understand your target market
- Have a solid business plan
The location of a retail property is crucial for several reasons. The first is that it can impact the demographics of the area. If the location is in a high-traffic area, there will likely be be a higher concentration of potential customers. This can lead to increased foot traffic and more business for the retailer.
Demographics are the characteristics of a population, such as age, gender, income, etc. An investor needs to consider demographics when choosing a retail property to purchase because it can give them insights into the type of customers that will be shopping at the property and what their needs and preferences are. This information can help the investor make decisions about the type of property to purchase and how to best market it to potential tenants.
Additionally, consider nearby competition as well. If there are other retailers in close proximity, it is essential to understand their business model and target market. This knowledge can help an investor determine if there is a niche that can be exploited.
When considering a retail property investment, it is also important to look at foot traffic. This information can be gathered through research or by talking to local businesses. It can give insight into the potential customer base for the property. Understanding the target market is crucial. This information can help an investor determine what type of retail business would be most successful in the space.
Finally, having a solid business plan is essential. This document should outline the goals of the business, the target market, and the financial projections. Without a well-thought-out plan, it will be difficult to make a retail property investment successful.
These six factors are important considerations when choosing a retail property for investment purposes. By taking the time to research each one, an investor can make a better decision that will lead to profitability.
The Bottom Line on Investing in Retail
Investing in retail property can be a wise decision for investors who do their homework and choose their properties carefully. Retail properties offer the potential for high returns, and they can be an excellent way to diversify one’s portfolio. However, it is important to understand the risks involved before making any investment. By following the tips outlined above, investors can greatly increase their chances of success when investing in retail property.
What to Know About Investing in Industrial
For savvy commercial real estate investors, one of the smartest choices is industrial property. Depending on your location and the current market conditions, industrial can offer significant returns with relatively low risk.
As the industrial market continues to heat up, investors would be wise to keep an eye on this asset class. Industrial properties offer a unique combination of strong rental growth potential and low volatility, making them an attractive investment for those looking to ride the wave of this booming market.
So if you’re looking for a smart way to grow your portfolio, read on for what you need to know about investing in industrial property.
Different Types of Industrial Property
The industrial property market has been on fire over the past several years, with strong demand and rental growth across all three major sub-types: warehouse/distribution, manufacturing, and office service/flex.
The main drivers of this robust demand are the continued growth of e-commerce and the ensuing need for last-mile distribution centers, as well as the ongoing shift of manufacturing operations back to the U.S. from China and other overseas markets.
Let’s take a closer look at each of these three types of industrial property and discuss why they’ve been in such high demand lately.
The growth of e-commerce has been a major tailwind for the warehouse/distribution sub-type. As more and more consumers do their shopping online, retailers need ever-larger warehouses and distribution centers to store and ship their products.
What’s more, the rise of e-commerce has spurred the development of new “last-mile” distribution centers, which are smaller facilities located closer to urban areas where most consumers live. These last-mile distribution centers help ensure that online orders can be delivered quickly and efficiently.
The other primary driver of industrial demand has been the shift of manufacturing operations back to the U.S. from China and other overseas markets. This so-called “reshoring” trend has been driven by a number of factors, including rising wages in China, the increasing cost of shipping goods from overseas, and concerns about the reliability of overseas supply chains.
As manufacturing operations have moved back to the U.S., they’ve needed new or expanded facilities to house their operations. This has been a major boon for the industrial market, especially for manufacturers located near population centers with high demand for their products.
Office Service/Flex Facilities
The third major type of industrial property is office service/flex space, typically used by businesses that need a mix of office and warehouse space, such as start-ups or tech companies. The growing popularity of coworking spaces has also helped drive demand for office service/flex space in some markets.
These facilities have become increasingly popular in recent years as businesses look for ways to reduce overhead costs. And with the rise of e-commerce and the resulting need for last-mile distribution centers, office service/flex space near urban areas has become especially coveted.
Benefits of Investing in Industrial Commercial Real Estate
Investing in industrial commercial real estate comes with several benefits, including:
- Strong rental growth potential: The continued growth of e-commerce and the ensuing need for last-mile distribution centers is expected to drive solid rental growth for industrial properties in the years to come.
- Low volatility: Industrial properties tend to be less volatile than other asset classes, such as office or retail, making them a relatively safe investment.
- Diversification: Adding industrial property to your portfolio can help diversify your holdings and reduce your overall risk.
- Attractive yields: Industrial properties typically offer higher yields than other types of commercial real estate, making them an attractive investment for income-seeking investors.
- Limited supply: The industrial market is currently undersupplied in many markets, which could lead to even more substantial rental growth and higher yields in the future.
Industrial commercial real estate is worth considering if you’re looking for a safe and profitable investment. And, with the strong tailwinds of e-commerce and the reshoring trend, now is a great time to invest.
Risks Associated with Industrial Properties
Like any investment, industrial properties come with certain risks. Here are some of the biggest potential risks associated with investing in industrial properties:
- Growth of e-commerce could slow down: While the growth of e-commerce has been a major tailwind for the industrial market, there’s always the risk that this trend could reverse course.
- Reshoring trend could reverse: The return of manufacturing operations to the U.S. from China and other overseas markets has been a major driver of demand for industrial space in recent years. However, this trend could reverse if the U.S. becomes less attractive as a manufacturing destination or if other countries start to offer more competitive costs.
- Interest rates could keep rising: Rising interest rates could pressure industrial property owners, as higher borrowing costs make it more expensive to finance their properties. This could lead to lower investment activity and slower rental growth in the market.
- Development of autonomous vehicles could disrupt logistics: If self-driving trucks become a reality, it could lead to a decrease in demand for warehouses and distribution centers, as goods can be shipped directly from manufacturers to consumers without the need for intermediate storage.
What to Look for When Evaluating an Industrial Investment Property
Investing in industrial commercial real estate can be a great way to boost your portfolio’s performance. Still, it’s important to know what to look for before deciding. There are several factors to consider when looking for an industrial property to invest in:
The location of an industrial property is one of the most important factors to consider when evaluating an investment. Look for properties near major transportation hubs, such as highways, airports, and railroads. These locations will be more attractive to tenants who need to ship goods quickly and efficiently.
The size of an industrial property is also an important consideration. Make sure to choose a size appropriate for the type of tenants you’re targeting. For example, if you’re looking to attract distribution companies, you’ll need a larger facility than if you’re targeting light manufacturing businesses.
The condition of an industrial property can have a significant impact on its profitability. Be sure to inspect the property carefully and make sure that it is in good repair before making an offer. Otherwise, you may need to spend money on repairs or renovations before leasing it out, which can eat into your profits.
When evaluating an industrial property, check for amenities that will make it more attractive to tenants. For example, properties with on-site parking, loading docks, and security systems will appeal more to potential tenants than those without these features.
Another important factor to consider when evaluating an industrial property is its zoning. Make sure the property is zoned for the type of business you’re looking to attract. Otherwise, you may have difficulty getting the proper permits to operate your business.
The tax burden of an industrial property can also have a big impact on its profitability. Be sure to research the local property tax rates before making an offer on a property. Otherwise, you could face a large bill that eats into your profits.
By taking the time to evaluate all of these factors, you can make sure that you’re choosing an industrial property that will be profitable and suitable for your needs.
The Bottom Line on Investing in Industrial
Industrial properties can be a great investment for those looking to diversify their portfolio or income stream. There are a few things to keep in mind when considering an industrial property investment, such as the location of the property, the size and type of the property, and the potential uses for the property. Industrial properties can offer a number of advantages, such as high rental incomes, low vacancy rates, and long-term lease agreements. With careful planning and research, an industrial property can be a wise and profitable investment.
What to Know About Investing in Self Storage
Although the percentage of self storage investments may be low compared to the entire commercial real estate sector, the self storage industry is rapidly maturing into a core asset class on par with office, retail, multifamily, and industrial.
There are currently more than 1.9 billion square feet of self storage space in the U.S., and 13.5 million households use self storage space according to SpareFoot Storage Beat’s most recent study.
While self storage properties may fly under the radar screen of many, there are more self storage facilities in the U.S. than all of the Subway, KFC, Pizza Hut, and Taco Bell locations combined.
Characteristics of the self storage asset class
Self storage properties are often viewed as the ideal asset class for conservative investors seeking more predictable returns than value-add or opportunistic investments, especially because both general consumers and businesses rent self storage space.
As with most commercial real estate projects, the new construction of self storage facilities slowed during the pandemic. However, the new supply of self storage space in the pipeline remains steady, driven by robust investor demand and economic recovery.
Developers delivered 45 million square feet of self storage space last year, and another 50 million square feet will come onto the market in 2022. The national average monthly rent for self storage space is $1.40 per square foot, with the average self storage unit renting for $149 per month.
Self Storage Industry Trends in 2022
While self storage has long been used for consumer storage, businesses are also driving demand.
According to a recent ReporterLinker study, clothing manufacturers producing seasonal items are opting for temporary self storage space as a more cost-effective alternative to traditional year-round warehouse space.
E-commerce players are increasingly using self storage space to store products for last-mile delivery, helping to mitigate inventory management problems and strengthen supply chain operations.
Self Storage Performance Statistics
According to research and analysis by StorageCafe, the self storage industry continues to out-perform many other commercial real estate asset classes:
- The national average rent for a 10’ x 10’ self storage unit is currently $132 per month.
- Street rates for 10’ x 10’ non-climate controlled self storage units have increased by 3.5% year-over-year (June 2022 vs. June 2021).
- National rates for 10’ x 10’ climate controlled self storage rose by 3.2% year-over-year.
- All top markets have seen street rental rates increase year-over-year, and a total of 11 markets saw 10% or higher rent growth.
- The new-supply pipeline of self storage space has remained steady, with 44.8 million SF delivered in 2021, and 50 million SF expected to be delivered in 2022
- Self storage sales volume increased to $10.9 billion in 2021, more than two and a half times the previous year.
- Deal activity in the self storage sector was about 250% higher than in 2020, with investors like StorageMart and Life Storage purchasing 158 properties for a total of nearly $4 billion.
- Around 108 million SF of self-storage space changed hands in 2021, double the 54 million SF in 2020.
- Growth in the self storage sector is expected to remain positive, with demand driven by the pandemic recovery and the overall steady demand for self storage space.
Things to Know Before Investing in Self Storage
Gen Xers are by far the largest cohort of users of self storage space, with 54% of them keeping items in storage. The top reason for renting self storage units is downsizing, followed by relocation, not having enough space at home, and change in household size.
Overall, when looking at self storage rental patterns, 31% of users rent for between 2-6 months, while 40% rent for over one year. Over 60% of self storage users rent unit sizes of 10’ x 10’ or larger, while about the same percentage of men and women rent self storage space.
Here are some of the pros and cons of investing in the self storage asset class:
- Minimal construction costs with self storage units easy to build and maintain.
- Economically resilient with self storage seeing demand through all economic cycles.
- A flexible business model with short-term leases allows owners to adjust rental rates to market demand.
- Value-add revenue streams from products such as packing supplies, moving equipment, and tenant-insurance.
- Self storage unit mix and amenities – such as interior vs. drive-up space, climate-controlled, and 24/7 access – must be carefully analyzed to meet the local market’s needs.
- Hiring and retaining on-site management for larger self storage facilities can be challenging.
- Changing tenant demographics may affect the future demand for self storage space.
- Month-to-month leases can mean a larger percentage of tenant turnover.
The Bottom Line
If you’re thinking about investing in commercial real estate, there’s a lot to consider. From the type of property you’re interested in to the financing and budgeting involved, there’s a lot to learn. But don’t let that intimidate you – with the right information, investing in commercial real estate can be a great way to build your wealth.
This article covered some of the basics of commercial real estate investing, including why it can be a smart investment, how to get started, and what to keep in mind when considering different types of properties. Remember that no two investments are exactly alike, so do your homework and talk to experts before making any decisions. With careful planning and execution, commercial real estate investing can be a great way to achieve your financial goals.