Commercial Real Estate Investing 101: How to Get Started

Key Takeaways:


Investing in real estate is a great way to build wealth. Commercial real estate investing, in particular, is known to provide some of the highest income streams. If you’ve been investing in residential real estate for a few years and have been wondering how to invest in commercial real estate, this guide serves to break down everything you need to know to get started.

Commercial Real Estate Investing Trends In 2021: What’s New

Offices, hotels, retail stores, and other commercial real estate investments have suffered heavily during the COVID-19 pandemic in 2020. While the pandemic isn’t over yet, commercial real estate is expected to follow a broader economic recovery trend in 2021. Many commercial real estate investors are optimistic as two COVID-19 vaccines have now been introduced.

While the start of 2021 will not promise any recovery, experts suggest commercial real estate will begin to stabilize by the end of the year. According to Kathy Feucht, global real estate leader at Deloitte, commercial real estate investors plan to reduce costs by around 25% in 2021. However, a new demand for health-related amenities, such as new ventilation systems, may actually up to cost up to $20.00 per square foot.

Depending on the type of commercial real estate investment, there are several different predicted trends for 2021. Let’s take a look at how these different properties are expected to perform:

  • Retail Stores: Several retail and department went bankrupt in 2020 and even more are expected to go empty in the first half of 2021. As more and more consumers shop online, experts predict there will be up to 25% fewer retail stores by 2025. Retail stores in urban areas, like New York and San Francisco, are expected to be replaced with healthcare, grocery, and other alternative stores.

  • Offices: According to CBRE, office demand could be permanently cut by 15% as more companies shift to work-from-home policies. As a result, office building supply will continue to increase. However, it is predicted that offices are expected to stabilize again by the end of 2021 as around 85.7% of companies plan on returning to the office.

  • Hotels: Hotels are predicted to struggle all throughout 2021. Most are not expected to recover until 2023, and upscale hotels that offer amenities for travelers won’t stabilize until 2025. Hotels in more populated cities will suffer the most as many are trying to steer away from densely populated areas.

  • Warehouses: Warehouses are expected to be the leading performer among commercial real estate investments. Their success is due to companies trying to keep up with the growing demand for e-commerce orders. Real estate experts predict an additional demand of 250 million square feet for warehouse space in 2021.

  • Apartments: Initially, apartments were expected to struggle during the pandemic as many would be unable to pay rent. However, multifamily properties are performing well as the demand for housing has not decreased. With apartments at more attainable prices and historically low-interest rates, they are expected to remain stable in 2021.

Commercial Real Estate Investing Trends In 2020

Commercial real estate, much like the rest of the industry, will face some big changes in the year to come. Most notably, this property sector will be affected by smart building technologies, changing homebuyer preferences (I’ll explain below), and job growth in a few key markets. By keeping up with each of these trends, investors can bolster their deal analyzers and make smarter investment choices in 2020.

One of the biggest changes to the real estate industry in recent years has been adopting new technologies, and 2020 will be no different. Commercial investors have already seen portions of the closing process, property management, and even the search for tenants to move online somehow. Next on the list is the implementation of smart building technology. This refers to systems with the ability to either bolster building security or improve overall tenant experiences. For example, with the help of new technology, property owners could automate a building’s central operations (including the heating, air, lighting, and security systems). According to the Wall Street Journal, 68 percent of tenants would pay more in rent for a smart building.

Investors should also be aware of how changing homebuyer demographics and preferences are beginning to impact the commercial real estate industry. Many millennials are interested in moving to the suburbs but are still hesitant to sacrifice the benefits of living in an urban area. This signals the rising popularity of mixed-use buildings and the potential to reach new suburban markets. Millennials want walkable resources, and commercial investors would be wise to anticipate these preferences.

In terms of the emerging commercial markets of 2020, investors should look at property development in cities with increasing job opportunities. A study from the Urban Land Institute showed that Austin, TX; Raleigh, NC; Nashville, TN; Charlotte, NC; and Boston, MA are among the top areas for overall investment prospects. Commercial investors may find it beneficial to research existing properties in these areas and potential land investments.


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how to get into commercial real estate

Commercial Real Estate Investing Trends In 2019

Not unlike their residential counterparts, commercial real estate investing trends are subject to cyclical changes. In fact, you could easily argue that commercial real estate investing is subjected to more changes than those found in the residential market. If for nothing else, the commercial real estate industry is made up of several sectors: industrial, retail, multifamily, office, and hotel—to name a few. Consequently, each sector’s expectations are at the mercy of unique needs and demands, not the least of which change in conjunction with the economy. Needless to say, countless variables will inherently influence the performance of any commercial real estate sector, and investors need to be aware of how they impact current and future trends.

As the book started to close in 2019, one commercial real estate sector stood out from the rest: industrial real estate. According to the NCREIF Property Index (NPI), “the top-performing CRE sector right now is industrial.” Comprised of warehouses, manufacturing facilities, refrigeration and storage assets, data centers, and other assets, industrial real estate is actually outperforming apartment, office, and retail sectors by a large margin. Thanks in large part to the growth of online shopping, industrial, commercial real estate assets are actually at the forefront of the U.S. economy, and their value has never looked better.

It is worth noting that while commercial real estate had been incredibly appealing in 2019, its reputation as “too expensive” for the average investor continues to be a part of the conversation. The higher price tag of commercial real estate has been disrupted by a new trend intent on leveling the playing field: crowdsourcing. The ability to crowdsource a commercial real estate investment is not only becoming more feasible, but it’s also more common than ever. The ability to crowdsource funds for investing in commercial real estate now allows real estate investors to transition from residential deals into commercial deals, which bodes well for a bright future. That said, it’s fair to assume we will start to see more small investors breaking into the commercial world.

What Qualifies As “Commercial Real Estate?”

Commercial real estate is a property that is typically leased out for business and retail purposes. Investing in commercial real estate involves the purchase or development of properties that have been designed with the intent of housing commercial tenants. Unlike a residential real estate investor, commercial real estate investors lease out and collect rent from the businesses that occupy space in their properties rather than from residential tenants. It should also be noted that raw land purchased for commercial property developmentally is also included in this definition. Commercial properties can generally be categorized into five main types. Keep reading to learn more about each one.

The 5 Types Of Commercial Real Estate

Before we get into the mechanics of how to invest in commercial real estate, it’s important to understand the various types of commercial properties. This way, you can start thinking about the commercial asset type in which you want to specialize. Commercial properties serve a broad range of purposes but are generally grouped into the following types:

  • Office

  • Retail

  • Industrial

  • Multifamily

  • Special Purpose

1. Office

The most common commercial real estate type is office space. These buildings, which can range from single-tenant offices to skyscrapers, are defined by one of three categories: Class A, Class B, or Class C.

  • Class A commercial real estate properties are typically newly built or extensively renovated buildings located in excellent areas with easy access to major amenities. Professional real estate management companies typically manage them.

  • Class B commercial real estate properties are often older buildings that require some capital investment. Although they are well-maintained and managed, these properties require minor repairs and upgrades—making them a popular target for investors.

  • Class C commercial real estate properties are typically used for redevelopment opportunities. They are generally poorly located, require major capital investments to improve out-of-date infrastructure, and their high vacancy rates are much higher than higher-classed buildings.

2. Retail

Another popular commercial real estate type is retail buildings. These properties, which range from strip malls and community retail centers to banks and restaurants, are often located in urban areas. The size of these real estate properties can extend anywhere from 5,000 square feet to 350,000 square feet.

3. Industrial

From warehouses to large manufacturing sites, industrial buildings are typically geared towards manufacturing industries, as they offer spaces with height specifications and docking availability. Also, these commercial properties generally lend themselves more to investment opportunities.

4. Multifamily

Multifamily properties are comprised of apartment complexes, high-rise condominium units, and smaller multifamily units. Property is qualified as multifamily real estate any time it has more than one unit, but can also be considered a commercial property if it has more than four units. Many residential investors get their start in commercial properties by expanding into larger multifamily properties. Residential tenants tend to have shorter lease terms than office and retail tenants, so tenant turnover is a factor that should be considered.

5. Special Purpose

In general, special purpose properties are designed for a specific use, so much so that it would be difficult to repurpose the property for another use. Car washes, self-storage facilities and schools are all examples of special purpose properties. The leisure and tourism industries represent a large proportion of special purpose real estate as well. Common examples within the industry include hotels, airports and sports stadiums, and amusement parks.

Mixed-use development properties are also prevalent in the commercial real estate sector and continue to grow in demand. These properties represent a mix of different uses, such as residential, retail, and even the public sector. A mixed-use building could have shopping and services on the first floor with apartment units on the upper floors. Read our guide to mixed-use developments to find out why they have become so popular in recent years.

What Is Owner Occupied Commercial Real Estate?

Owner-occupied commercial real estate (OOCRE) is when investors purchase commercial real estate to utilize the building for their own purposes. This strategy can be applied to any of the five commercial real estate types discussed above.

Having the option to occupy the commercial real estate you invest in is just one of the many benefits associated with commercial investing. Keep reading to find out some of the other benefits that may pique your interest.

The Many Benefits Of Commercial Real Estate Investing

Investing in commercial real estate can be very rewarding, both personally and financially. For many, the objective of investing in commercial real estate is for future wealth and security; others utilize it for tax benefits and investment portfolio diversification.

A commercial redeveloper can also take advantage of the following benefits:

  • Higher Income: The hallmark benefit of investing in commercial real estate is a higher potential income. Generally speaking, commercial properties have a better return on investment, an average of six to twelve percent, while single-family properties fetch between one and four percent. Secondly, commercial real estate provides a lower vacancy risk, as properties tend to have more available units. (Consider this: one vacancy in an office building with 25 commercial spaces will negatively impact an investor’s bottom line more than one vacancy in a residential duplex.) Also, commercial leases are generally longer than those you will find in residential real estate. This means that commercial real estate owners have to deal with far less tenant turnover.

  • Cash Flow: Commercial real estate has one very distinct advantage: a relatively consistent stream of income due to longer lease periods. In addition, commercial properties often have more units than residential properties, which means you can achieve economies of scale and multiply your income streams much more quickly. Known in the industry as a triple net lease, many commercial tenants also pay the building’s real estate taxes, property insurance, and maintenance costs, thus increasing your owner benefits.

  • Less Competition: Another advantage associated with commercial real estate is relatively less competition. Because of the perceived difficulty of commercial investing, the commercial space tends to be less saturated with other investors.

  • Longer Leases: Perhaps one of the biggest perks of commercial real estate is the attractive leasing contracts. Commercial buildings generally have longer lease agreements with tenants compared to residential properties, which, as previously stated, offer investors impressive returns and significant monthly cash flow. In many cases, lease agreements for commercial properties are signed for multiple years.

  • Business Relationships: The world of commercial real estate offers investors the unique opportunity to participate in business-to-business relationships. This can lead to more professional, neighborly interactions with your tenants when compared to residential real estate. In some cases, you may even be able to build relationships with the business owners renting in your building. This can be great for expanding your network and getting involved in the community you are investing in.

  • Limited Operational Hours: One of the lesser-known perks of operating commercial real estate is that, for the most part, you share working hours with your tenants. While business hours can vary slightly, commercial property owners typically won’t find themselves answering around-the-clock maintenance requests or other tenants’ communications. Residential real estate, on the other hand, can demand an on-call staff member to deal with issues 24/7. Many commercial investors who choose to manage their own properties enjoy this benefit, as it helps allow for a sense of separation between property ownership and regular life.

Commercial real estate investing offers investors an array of opportunities and advantages that other investment strategies do not. Once the benefits of commercial real estate investing are recognized, the next step is to dive in. Read the following to receive tips on how to get started in commercial real estate.

How To Invest In Commercial Real Estate: Getting Started

The question of ‘how to invest in commercial real estate’ has only one answer: due diligence. Regardless of what sector or niche you’re in, doing your homework and minding your due diligence is critical in ensuring your success in real estate. Besides learning the ins and outs of commercial investing, make sure you understand the commercial real estate market and how it can differ from the residential real estate market. If you’re ready to embark on your first commercial endeavor, be sure to abide by the following tips:

1. Understand How Commercial Real Estate Is Different

The first step as a commercial investor is understanding that commercial real estate is valued differently from residential properties. Unlike residential real estate, the income from commercial real estate is typically related to usable square footage. Also, commercial property leases typically last longer than residential leases. These two factors help illustrate why a commercial real estate investor has a better potential to earn a higher income.

Location is an important factor regardless of your investing niche, with commercial investing as no exception. However, commercial investors also need to pay close attention to their tenant type. The location and intended tenant type are two factors that intersect closely when determining demand. For example, a space intended for corporate offices will likely have better performance in an urban center than a primarily residential neighborhood. Analyzing recent comparables can provide you with a better clue as to how your property of interest might perform.

2. Analyze Comparables

The next step is to analyze comparables in the area and research future developments. Otherwise known as “comps,” these assets refer to prices paid for recently sold properties that are similar in location, size, and style. Analyzing comps will help you determine the current market value of a property. A general rule of thumb when determining comps is to choose a property where the square footage does not go beyond 10 percent higher or lower than that of the property being evaluated. This will allow for the most accurate comparables possible. Read more on tips for pulling the most accurate comparable sales.

3. Use The Right Success Metric

Commercial real estate investing involves a wide array of calculations and an understanding of real estate finance. To be a player in commercial real estate, there are several formulas you should know.

  • Net Operating Income: This is a calculation that equals all revenue and costs from a particular property. Configured before taxes, this number provides investors with an idea of how much they’ll make from an investment minus all necessary operating expenses. Operating costs typically consist of insurance, property management fees, utilities, repairs, janitorial fees, utilities, and property tax.

  • Cap Rate: Used to calculate the value of income-producing properties, the “cap rate” — short for capitalization rate — will provide investors with an estimate of future profits or cash flow. This is essentially the ratio of net operating income to the property asset value.

  • Cash On Cash: Cash on cash is a metric that provides investors with a rate of return on their commercial real estate transactions. It’s typically used by investors who rely on financing to purchase their properties. Cash on cash measures the return on out-of-pocket cash invested relative to the portion that was financed. This will provide an accurate analysis of an investment’s performance.

The above formulas serve as an introduction to complement our complete guide to real estate calculators that every investor should know.

4. Commercial Real Estate Investing Mistakes To Avoid

As a commercial real estate investor, it’s just as important to know what not to do as it is to know what to do. Today’s best investors already know it, and it’s about time you did too: mitigating risk is the single greatest thing a real estate entrepreneur can do for the success of their business. Mitigating risk exposure is the best way to increase the likelihood of success. That said, here’s a list of some of the most common mistakes commercial real estate investors need to avoid:

  • Improper Valuations: Every single commercial property is unique, and investors need to be able to account for variances that may be found in each asset. Failure to account for every detail involved in an asset’s valuation could lead to financial ruin. Therefore, commercial real estate investors must be fully aware of what they are buying and for how much. The inability to account for the try value of a property will impact nearly every step moving forward, so it’s important to get things right at the time of acquisition.

  • Financial Ignorance: Failing to understand the financial intricacies of commercial real estate investing can be devastating. IF for nothing else, commercial deals are not the same as residential ones. Investors will need to learn the differences, not the least of which include the loan-to-value (LTV) or debt service coverage ratio (DSCR).

  • Neglecting Due Diligence: While today’s market requires decisive decision making, it’s important to mind due diligence. It’s better to lose a deal to someone else than to buy into a deal you aren’t prepared for. As a result, more investors need to take the appropriate time to learn as much about a property as they can before they buy it.

  • Not Working With a Team: Far too many investors want to save money by doing everything themselves. However, working with a team is unequivocally better than working alone. While you may appear to save money on the surface, chances are you are losing both money and time by working alone. That said, align your services with a competent team and trust them to do the job you hired them for. There’s a good chance they know more about every process than you do.

In this next section, we will discuss how to obtain different types of commercial investment loans. Being well-versed in the above formulas and calculations is critical when presenting your case to commercial lenders.

investing in commercial real estate

Types Of Commercial Real Estate Loans

Now that you’ve received an overview of commercial real estate investing, including its benefits and ideas on how to get started, you’ll need to start thinking about an important aspect: How will you go about financing these investments?

There is a wide range of commercial investment loan types, and it is up to the investor to decide which financing option best fits their needs. Each type of loan has unique eligibility requirements, such as a minimum credit score, experience level, and down payment requirement. These loans also have varying terms, including the loan term, interest rate, and loan-to-value (LTV) ratio. For example, one investor may be in search of a loan that offers lower interest rates over a longer loan term, while another investor’s priority might be finding a short-term loan as a means of bridging a financial gap. Be sure to visit our comprehensive guide to the different types of commercial real estate loans shown below:

  • Small Business Administration (SBA) 7(a) Loan

  • Certified Development Company (CDC) / SBA 504 Loan

  • Conventional Loan

  • Commercial Bridge Loan

  • Hard Money Loan

  • Conduit Loan

How To Get A Commercial Real Estate Loan

The idea of obtaining commercial real estate financing may seem intimidating at first. Still, investors who spend the time learning about the process and the different types of commercial real estate loans will find that they are completely attainable. Below are the main steps involved in obtaining a commercial investment property loan:

  • Individual Vs Entity: Step one is to determine whether to finance a commercial property as an individual, or as an entity. Although most commercial real estate is purchased by business entities such as corporations, developers, and business partnerships, it can easily be completed as an individual investor. The lender essentially wants to make certain the borrower can repay the loan, thus requiring borrowers to provide financial track records to secure a loan. The lender will typically require the investor(s) to guarantee the loan for newer businesses with no credit history.

  • Mortgage Options: It is important for investors to recognize that residential and commercial mortgages are not the same. First, unlike residential mortgages, commercial loans are not backed by government agencies such as Freddie Mac and Fannie Mae. Secondly, commercial loan terms differ from those of residential properties. Commercial loans range from five to 20 years, whereas residential loans will typically range from 15 to 30 years. Lenders will typically make their decisions based on an investor’s financial and credit history.

  • Loan To Value Ratio: An important metric lenders consider when financing commercial real estate is a property’s loan-to-value ratio (LTV). This figure measures the value of a loan against the value of the property. It is calculated by dividing the loan amount by the property’s appraisal value or purchase price. The LTV will range from 65 to 80 percent for commercial loans, with lower LTVs qualifying for more favorable financing rates.

  • Debt Service Coverage Ratio: Lenders also look at debt-service coverage ratio (DSCR). This metric measures a property’s ability to service debt. It compares a property’s annual net operating income to its annual mortgage debt service, including principal and interest. A DSCR of less than one percent reveals a negative cash flow. Commercial lenders generally look for DSCRs of at least 1.25 to ensure proper cash flow.

Once you’ve secured your financing, you are ready to start searching through listings. However, this is a lot of information to process at once. Keep reading to have some of your most burning questions answered.

Commercial Real Estate For Beginners

A successful commercial real estate investor has the potential to have a very lucrative career. Many beginner investors use multifamily properties as a gateway to get into commercial real estate investing. Regardless, it is imperative that you have a proper business plan before getting started. Here are the answers to a few commonly asked commercial real estate questions every beginner investor should know:

commercial real estate faqs

How Do I Know If I’m Ready For A Career In Commercial Real Estate Investing?

Are you interested in commercial real estate investing but still feeling a little hesitant to take the leap? The following three questions were designed to help you gain more clarity on whether or not commercial real estate is for you:

Do you have the ability to think big?

Investing in commercial real estate requires individuals to think big and have an open mind. When investing in residential real estate, the properties under consideration are much smaller in scale. With a commercial property, you must visualize a finished product even in the beginning stages of redevelopment. If you are debating whether to purchase a five-unit apartment versus a property with ten or more units, it is probably more beneficial to choose the 10. If the five-unit complex requires nearly the same commercial financing as the 10, it makes sense to think big and do what it takes to boost your bottom line.

Are you an expert relationship builder?

Networking and building relationships as a residential real estate investor are important, but it is an absolute must for commercial investors. The biggest reason to build relationships with other commercial investors and private lenders is for financing purposes. When facing a one million dollars or more purchase price, you will likely need funding. What better way to find capital than to contact one of your personal private lenders with whom you’ve already built a relationship. Once you’ve built a network, you can rely on other individuals who have made and learned from their mistakes.

Can you successfully execute your due diligence?

Arguably the most important task beginner investors can do before jumping into commercial real estate investing is to perform their due diligence. After you’ve chosen your niche, you must research everything you can regarding that specific sector. Ask questions from like-minded individuals at your local REI club, find information about different types of financing options online, reach out to private lenders in advance. Hence, you know exactly what information to present them with when the time comes. Once you’ve carried out thorough due diligence, you will be ready to embark on your first commercial real estate deal successfully.

Summary

Commercial real estate investing may seem intimidating at first, but you should understand that the core skills and competencies required are the same as residential property investing. They include minding due diligence, having a proper business plan that includes an understanding of financing options, and building a strong network. Any type of investing is associated with some level of risk, and it’s up to you to find ways to mitigate that risk. If you use the systems that brought you success with residential real estate and seamlessly implement them into your commercial strategy, you will surely find success.

Interested in learning more about today’s most lucrative real estate strategies?

Whether you’re brand new to investing, have closed a few deals, or are a seasoned investor— our new online real estate class reveals the best real estate strategies to get started with real estate investing in today’s market. Expert investor Than Merrill explains how these time-tested strategies can help you to profit from the current opportunities in real estate.

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