The world is teeming with investment opportunities. Maybe you’ve looked into day trading or stock options, but you’ve been told real estate provides one of the highest ROIs in the long run.
If purchasing multiple single-family homes and renting them out to tenants doesn’t sound like the type of investing you’re looking for, commercial real estate might be a better option for you.
Knowing how to buy commercial real estate – including financing options and what properties are worth investing in – can give you the confidence you need to move forward.
Table of Contents:
What is Commercial Property?
Commercial property refers to real estate intended for generating income. Buildings with living spaces are classified as residential or commercial based on the number of units each has. If a building has four or fewer residential living spaces, it’s considered a residential building. If a building has five or more residential units, it’s considered commercial property.
Commercial real estate (CRE) property includes office buildings, medical centers, retail stores, hotels, and warehouses.
Types of Commercial Real Estate
There are five main types of commercial real estate. Each is divided based on the purpose of the space and will likely provide different levels of ROI based on location, function, and size.
| Commercial Real Estate Property Type |
- Industrial – Manufacturing buildings and distribution warehouses are two examples. These properties often house heavy equipment and docking areas for trucks to load and unload goods.
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- Office Space – Buildings that house multiple business offices. You can find many of these buildings in the financial districts of most major cities.
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- Retail – Includes shopping malls, mom-and-pop shops, and other buildings that house retail stores like Patagonia or Walmart.
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- Multi-family Housing – Real estate that contains five or more residential living spaces.
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- Hospitality – Hotels and restaurants are both examples of hospitality real estate.
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In some instances, a sixth category for special properties can be used if the property doesn’t clearly fit into the five previously mentioned.
The types of commercial real estate can be further broken down into the quality of the asset. This system is often referred to as grading and has three different classes – Class A, Class B, and Class C.
| Commercial Real Estate Gradings |
- Class A – Typically of the highest quality, boasting high-end finishes, modern design, state-of-the-art technology and a variety of sought-after amenities. Class A buildings are also in prime locations.
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- Class B – Many of these properties are in decent condition but relatively old and in need of a few updates. You may find historic buildings fall into the Class B category because of their naturally outdated features.
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- Class C – If a building fits into this tier, it likely needs many updates and isn’t in a prime location. These properties often have cheap rent and supply basic functionality.
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So, why invest in commercial property in the first place? Keep reading to learn about some of the benefits of investing in commercial vs. residential property.
Why Invest in Commercial Property?
Tax reductions, portfolio diversification, and return on investment are some of the biggest benefits of knowing how to buy commercial real estate. However, they aren’t the only ones.
- Tax Benefits: While taxes on capital gains from the stock market are difficult to reduce, it’s possible to significantly lessen the amount of taxes you pay on capital gains from CRE. One way to do this is by including the cost of the building’s depreciation on your annual tax reports.
- Upkeep and Maintenance: If your commercial property houses business owners who regularly have customers coming in and out, they’ll be more likely to keep the space well kept and professional.
- Stronger ROI and Cash Flow: The average return on investment for single-family homes amounts to only 1.32%, while low-rise apartments average a 9% ROI and industrial buildings average a 9.5% return.
- Portfolio Diversification: Diversifying your investment portfolio is the best way to build a safety net when the stock market goes bearish or other investments underperform. There’s also a number of ways to diversify within commercial real estate itself, providing additional support.
- Syndication Opportunities: If investing in a property on your own sounds daunting, real estate syndications involve one head person and multiple other investors who let the head person handle most of the transaction details. This enables you to benefit from CRE and passively invest, without having to do any legal reviews, inspections, or negotiations.
- Less Competition: Because investing in commercial real estate can be seemingly more difficult than investing in residential real estate, there are relatively fewer investors who aim for CRE ownership.
- Longer Leases: Commercial property lease contracts are often longer than residential lease contracts, supporting a higher cash flow and long-term ROI. Commercial lease agreements often last multiple years at a time.
How to Buy Commercial Property
Knowing how to buy commercial property can make the task feel more attainable. This process includes building your network, identifying available opportunities, quantifying your potential return, securing financing, and finally, closing the deal.
The intricacies of each step will vary depending on your specific investment strategy, available funds, and experience.
Step 1: Build Your Network
By building your network, you open doors to opportunities that are closed to outside investors. The best way to build your network is to find mentors who are willing to help you reach your goals.
Learning from those who have gone through the process is just the first step in knowing how to buy commercial real estate. Connecting with private investors, attorneys who understand real estate law, real estate agents, and property managers who can all offer their advice and services is crucial for being a successful commercial real estate investor.
Here at Revolution Realty Capital, we’re more than just a lender. We’re also a team of private investors with on-the-ground real estate experience to offer expertise throughout your investment journey.
Additional education methods include:
- Market reports
- Podcasts
- Ebooks
- Classes at local community colleges
- Real estate investing seminars
- Textbooks
- Blogs (like this one)
Investor Tip:
By learning how to underwrite your own commercial real estate deals, you can save money and improve your profit margin. |
Step 2: Identify the Opportunity
Before buying commercial real estate, ensure your investment will be profitable. You can do this by looking at the purchase price compared to similar building values in the market, current net operating income, and any repositioning opportunities.
Other considerations:
- How the property is zoned
- Property taxes
- Repairs needed
- Current rent prices
- Operating expenses
- Net Operating Income
Step 3: Quantify the Return
Return on investment can be calculated a few different ways. However, the property investment return method is generally preferred by commercial real estate investors as it takes into account rental income.
Property Investment Return:
[(Monthly Earnings x Length of Time) / Property Value] x 100%
For example, let’s say a commercial property is worth $800,000 and earns $10,000 each month.
Property Investment Return:
[($10,000 x 12 months) / $800,000] x 100% = 15%
Your property investment return would be around 15% in this example. However, keep in mind that ROI isn’t the same as profit. Other expenses, including loan repayment and maintenance costs, will eat into your bottom line.
Investor Tip:
By learning how to underwrite your own commercial real estate deals, you can save money and improve your profit margin. |
Step 4: Secure Financing
Numerous financing options exist for commercial real estate investments. Typical requirements for securing such financing often include an adequate down payment, exit strategy (for hard money loans), and equity or sufficient collateral.
