Now that the market is beginning to pick up, a lot of investors are wondering if now is the right time to begin commercial real estate investing. The transition from residential real estate into commercial real estate is common as an individual’s portfolio increases. An economy that is on the rebound and a surging housing market are indications that the commercial market will also rebound.
Getting started in commercial real estate investing can often be a daunting task. The price tag is typically much larger and the risks are amplified. Many new investors are also very unfamiliar with the market and the intricacies of understanding how it works. Commercial real estate investing will require some uncomfortable periods of doubt. The good news is that the rewards in commercial real estate investing are much larger.
Commercial Real Estate Investing 101
Before you can begin investing in commercial real estate it is a good idea to pick a market that you want to focus on. For a first time investment property it is a good idea to start with a property that is within driving distance. This will ensure that you are familiar with the market and allow you to easily verify that the property is running smoothly.
There are three main types of commercial investment real estate. Office, retail, and multifamily. All three have their pros and cons. The decision on which type of property to invest in will come down to what the investor is trying to achieve. It is also important to determine how much of a management burden investor wishes to take on.
Commercial Real Estate Investing Options
Office buildings and multi-tenant retail buildings are very similar investments. For both of these it is very common to have several businesses on short term leases. A short term lease is typically classified as three to five years. The benefit of this type of investment is that it allows the owner to increase rent to keep up with shifts in demand. It is important to keep in mind that the investor will also be susceptible to a decline in rent rates. In order to keep tenants in a poor market owners will have to be willing to renew leases at market rates. If market rates are lower than the initial rent, cash flow of the property will be significantly impacted.
Multi-family housing is an extremely popular form of commercial real estate investing. Investors are attracted to invest in multi-family properties because of the high demand for apartment housing. High demand allows owners to raise rents which leads to an increase in net operating income (NOI). Increases in NOI result in an exponential increase in the value of the property.
Before jumping into any type of investment it is important to consider the management costs and the amount of upkeep that will be necessary. In most areas, multi-family housing requires a great deal of management. Managers must maintain keep current tenants happy, maintain efficient vacancy levels, advertise for new tenants, screen tenants, and manage the day to day operations of the building.
Management of Commercial Real Estate
Managing multi-family investment property is a full time job. Many people who are new to commercial real estate investing underestimate the amount the time requirement. As a result, the property is not run efficiently and the value of the property suffers.
Office and multi-tenant retail buildings require less management than apartments. Due to leases that generally last a minimum of a couple years, tenant turnover is smaller than multi-family investments. Remember though, each of the tenants in the building represent a larger percentage of the property’s income. If one tenant leaves, income will take a significant hit. Generally, it is also more difficult to lease out an office or retail building than it is to lease an apartment.
Those who are looking to get started in commercial real estate investing to earn a passive income should consider triple net lease (NNN) properties. These properties offer investors an opportunity to own the real estate maintenance and management free. The most popular type of NNN investment property are those lease by investment grade retail tenants. Leases often last 10-25 years. Long term leases allow an investor to earn a long term, stable return on an investment that is backed by a large corporation.
I hope this article was informative in helping evaluate the pros and cons of different types of commercial real estate investments. Deciding which type of property fits your investment needs is the first step commercial real estate investing.