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NGExpert financial copywriter
Page written by Chris Godfrey. Last reviewed on August 23, 2024. Next review due October 1, 2025.
Investing in commercial real estate can be one of the safest investment strategies: Returns on investment can be high. Monthly cash flow can be strong. However, for those with low or zero commercial real estate experience, the business can be daunting. What kind of property should I buy? How should I buy it? What kind of money can I make? The unknowns can be worrying. However, worry no more. Simply follow the guide below to find out all you need to know before investing in commercial real estate.
Investing in US commercial real estate (CRE) requires thorough due diligence and careful analysis of the factors that may determine success or failure. Of these factors, location is paramount, as this can significantly affect property value and utility. For instance, a plot in a major city center may be ideal for an apartment building or retail space but will be unsuitable for a factory.
Understanding zoning laws is also crucial, as they define permissible property uses and may limit the number of units in an apartment complex or the required parking spaces per unit. Market trend analysis will help you to determine need and rental potential – a growing population in the targeted area indicates rising real estate demand, while a declining demographic could hinder investment success.
Lastly, your financial assessment should include detailed calculation of initial capital requirements, ongoing expenses, and revenue strategies, whether from capital appreciation or rental income. Consider tenant turnover and interest rate changes. Above all, pay attention to the small stuff. Detailed financial planning and strict adherence to a budget are key elements of any successful investment strategy.
As an investor, your goal is to identify and capitalize on the most profitable opportunities. While no universal answer exists for the best-performing real estate investment, certain indicators can guide your decisions.
Generally, properties with more tenants offer higher profit potential, as losing one tenant has less impact on income. Additionally, properties requiring less investment and infrastructure, such as residential vehicle parks and storage facilities, can yield high returns due to their low maintenance needs.
Retail and industrial properties can also generate significant returns, especially those with tenants on triple net leases, where tenants cover rent, taxes, and maintenance. This arrangement reduces ownership costs while providing steady income.
Flex industrial spaces are considered lower risk due to tenant stability and property flexibility. Conversely, as we saw during the Covid-19 pandemic, office buildings struggled due to huge changes in work habits.
Ultimately, like many other types of investment, real estate market performance varies over time and the success of different property types will always ebb and flow.
A good ROI depends on your investment options, financial goals, tax situation, and risk tolerance. Higher risk can yield higher returns, while cautious investors may prefer lower, more certain ROIs. Most CRE investors aim to meet or exceed the performance of a major stock index such as the S&P 500, where the historical average annual return is approximately 10%.
To attract external investment to your CRE project, a minimum of 8% annual cash-on-cash return (CCR) is essential, although 10%-12% would be much better. More important is the annual internal rate of return (IRR). This is income from operations and appreciation combined. Commercial properties almost always earn more from appreciation (their rising value) than they do from operations. The higher this number is the better.
Investing in commercial real estate has advantages and disadvantages:
Pros:
Cons:
Commercial real estate investing may have different tax implications than other investments. For example, in the US, commercial properties depreciate over 39 years, compared to 27.5 years for residential properties. This means smaller annual tax deductions. Additionally, selling commercial property will often incur capital gains tax in the sale year without the option of deferrals.
On the plus side, some states and jurisdictions may offer tax incentives for commercial properties. This can include lower rates or tax credits that are designed to encourage business development, especially in designated areas.
Like most other financial strategies, tax rules and regulations for commercial property investment can be complex for anyone other than an accountant. Talking to a tax professional is therefore strongly advised before investing in commercial real estate.
Commercial real estate has the potential to generate good returns on investment (ROI) and strong monthly cash flows. However, investing in CRE comes with risks, especially for entrepreneurs who invest directly by buying or building commercial space, leasing it to tenants, and managing the properties. Sudden changes in the real estate market, a slow economy, or the default of a major tenant could leave investors on the hook for large debts and limited or no rental income to pay them with.
It rarely makes sense to buy commercial real estate with cash. Instead, most business owners, investors and real estate developers will use a mix of cash and a commercial mortgage to buy the property they need. The benefits of this strategy are multiple – it reduces strain on cashflow, protects cash reserves, and may give the borrower the option of buying more property if they can meet lender credit requirements and demonstrate their ability to meet scheduled loan payments.
Commercial mortgages are business loans that you could obtain by approaching banks, credit unions and online lenders one by one, or you could use the services of a loan marketplace that will immediately introduce you to a choice of real estate loans from different lenders. Some marketplace platforms can also give you advice and help you with the application process. This can be especially useful for borrowers who have never taken out a commercial mortgage before.
Let’s be honest. It‘s very difficult to invest in anything with no money. If you have zero skin in the game, why do you deserve a return? However, that said, there may be ways to get started in commercial real estate without having any cash, although you will need to attract third-party investors. What will they need to see to get excited about your proposal? Possible entry points include:
For a commercial mortgage or any type of business loan, working with business finance experts can make all the difference when applying for funding. Contact Swoop to discuss your borrowing needs, get help with your application and to compare high-quality commercial mortgages and business loans from a choice of lenders. Claim the high ground in US commercial real estate. Register with Swoop today.
Written by
Chris is a freelance copywriter and content creator. He has been active in the marketing, advertising, and publishing industries for more than twenty-five years. Writing for Wells Fargo Bank, Visa, Experian, Ebay, Flywire, insurers and pension funds, his words have appeared online and in print to inform, entertain and explain the complex world of US consumer and business finance.
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At Swoop we want to make it easy for SMEs to understand the sometimes overwhelming world of business finance and insurance. Our goal is simple – to distill complex topics, unravel jargon, offer transparent and impartial information, and empower businesses to make smart financial decisions with confidence.
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