Investing in real estate is a tried and tested method to build wealth, and commercial real estate investing has emerged as one of the most lucrative avenues. If you've been involved in residential real estate for some time and are curious about venturing into the world of commercial real estate, this comprehensive guide will provide you with everything you need to get started.
Commercial Real Estate Investing Trends in 2022
The COVID-19 pandemic has had a significant impact on commercial real estate investments, with offices, hotels, and retail stores bearing the brunt of the crisis. However, the industry has shown resilience and adaptability, and experts predict a trend of economic recovery in the coming year.
Julian Goldie, CEO of Goldie Agency, emphasizes the potential for outsized profits, consistent yields, volatility hedges, and unique tax benefits in the commercial real estate market. He suggests that the post-COVID rebound and infrastructure spending will create tailwinds, attracting more investors to the market.
While the overall outlook for commercial real estate is positive, specific predictions vary depending on the type of investment. Let's explore how different properties are expected to perform in 2022:
Retail Stores
Several retail and department stores filed for bankruptcy in the past year due to quarantine measures and high COVID-19 transmission rates. Experts predict that up to 25% of retail stores may disappear by 2025, especially in urban areas like New York and San Francisco. However, vacant retail spaces are likely to be replaced by healthcare, grocery, and other alternative stores.
Offices
The shift towards remote work is expected to have a lasting impact on office demand. Experts predict a permanent reduction of around 15% in office demand as companies adopt hybrid work policies. However, the emergence of such policies, requiring employees to be in the office only a few days a week, may stabilize the demand for office spaces.
Hotels
Hotels have been hit hard by travel restrictions, and their recovery is likely to be slow. Experts believe that many hotels will not regain stability until 2023, and upscale hotels that cater to travelers may take until 2025 to stabilize. Hotels in densely populated cities are expected to suffer the most as people seek less crowded areas.
Warehouses
Warehouses are expected to be the top-performing commercial real estate investment. E-commerce growth has driven an increased demand for warehouse space, with experts predicting a need for an additional 250 million square feet in 2021.
Apartments
Initially, apartments were expected to struggle during the pandemic. However, the demand for housing has remained strong, and multifamily properties have performed well. With historically low-interest rates and more accessible pricing, apartments are expected to remain stable in the coming year.
Rental Property Upgrades
As people adapt to work-from-home lifestyles, there may be an increased demand for larger rental units. Upgraded units are likely to gain popularity in competitive markets as renters look for improved living arrangements.
Commercial Development
Housing markets across the country are trying to meet the growing demand for housing. This opens up opportunities for commercial investors skilled in development projects to embark on new builds in the year ahead.
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What Qualifies as "Commercial Real Estate?"
Commercial real estate encompasses properties leased out for business and retail purposes. Unlike residential real estate, commercial properties generate income from businesses that occupy them. This definition also includes raw land purchased for commercial property development. Commercial properties can be categorized into five main types:
1. Office
Office spaces are the most common type of commercial real estate. They range from single-tenant offices to skyscrapers and are classified as Class A, Class B, or Class C. Class A properties are newly built or renovated buildings in prime locations, while Class B properties are older but well-maintained. Class C properties offer redevelopment opportunities.
2. Retail
Retail buildings include strip malls, community retail centers, banks, and restaurants. They are commonly found in urban areas and can vary in size from 5,000 to 350,000 square feet.
3. Industrial
Industrial buildings, such as warehouses and manufacturing sites, cater to manufacturing industries. They provide specialized spaces with height specifications and docking availability. Industrial properties also offer investment opportunities.
4. Multifamily
Multifamily properties include apartment complexes, high-rise condominiums, and smaller multifamily units. Properties with more than four units fall under commercial real estate. Many residential investors venture into commercial real estate by expanding into larger multifamily properties.
5. Special Purpose
Special purpose properties are designed for specific uses that make repurposing difficult. Examples include car washes, self-storage facilities, and schools. Leisure and tourism industries, like hotels, airports, and sports stadiums, also fall under special purpose real estate. Mixed-use developments, combining residential, retail, and public sectors, have gained popularity.
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The Many Benefits of Commercial Real Estate Investing
Investing in commercial real estate offers numerous benefits, both personal and financial. One of the main advantages is the potential for higher income compared to residential properties. Commercial real estate provides higher returns on investment, lower vacancy risks, and longer lease agreements, resulting in a consistent cash flow.
Other benefits include less competition, professional relationships, limited operational hours, and the opportunity for capital appreciation. Commercial real estate investments allow investors to diversify their portfolios and take advantage of tax benefits. Overall, commercial real estate offers unique advantages that can contribute to long-term wealth and security.
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How to Invest in Commercial Real Estate: Getting Started
Embarking on a commercial real estate investment requires careful due diligence and a solid understanding of the market. Here are the key steps to get started:
1. Understand How Commercial Real Estate Differs
Commercial real estate is valued differently from residential properties, with income generation and usable square footage playing crucial roles. Familiarize yourself with the commercial real estate market and its unique dynamics compared to residential real estate. Location and tenant type are critical considerations, as they impact demand and potential returns.
2. Analyze Comparables
Analyze comparable properties (comps) in the area to determine market value and understand pricing trends. Accurate comparisons help assess the potential of a property and inform decision-making. Ensure that the comps closely match the property being evaluated in terms of location, size, and style.
3. Use the Right Success Metrics
Familiarize yourself with key metrics in commercial real estate investing, such as net operating income (NOI), cap rate, and cash-on-cash return. These metrics provide insights into profitability, return on investment, and cash flow potential. Understanding and using these metrics will enable you to make informed investment decisions.
4. Reserve Cost Contingencies
Allocate a portion of your budget to cost contingencies to cover unexpected expenses, such as early vacancies or property renovations. Having a contingency fund ensures you can handle upfront costs and maintain financial stability during the investment process.
5. Avoid Common Mistakes
Mitigate risks by avoiding common commercial real estate investing mistakes, such as improper valuations, financial ignorance, neglecting due diligence, and working alone without a competent team. Educate yourself, build a network, and seek guidance to increase your chances of success.
Types of Commercial Real Estate Loans
Financing commercial real estate investments is crucial for many investors. Various loan types suit different needs, and each has its own eligibility requirements and terms. Here are some common types of commercial real estate loans:
- Small Business Administration (SBA) 7(a) Loan
- Certified Development Company (CDC) / SBA 504 Loan
- Conventional Loan
- Commercial Bridge Loan
- Hard Money Loan
- Conduit Loan
Understanding these loan options allows you to choose the financing option that best aligns with your investment goals and financial situation.
How to Get a Commercial Real Estate Loan
Obtaining commercial real estate financing may seem daunting, but understanding the process makes it achievable. Here are the main steps involved:
- Determine whether you will finance the property as an individual or entity.
- Familiarize yourself with commercial mortgage options and their terms.
- Understand loan-to-value ratio (LTV) and debt service coverage ratio (DSCR) used by lenders to assess risk and eligibility.
- Preparing your financial and credit history to present to lenders.
Once you secure financing, you can start searching for commercial real estate opportunities with confidence.
Commercial Real Estate for Beginners
Entering the world of commercial real estate investing can be intimidating for beginners. However, with the right mindset and knowledge, you can overcome your reservations and embark on a successful career. Here are answers to common questions that every beginner investor should know:
- How Do I Know If I'm Ready for a Career in Commercial Real Estate Investing?
- Do You Need a Real Estate License?
- Summary
Building a strong network, conducting thorough due diligence, and having the ability to think big are essential qualities for commercial real estate investors. Obtaining a real estate license can provide additional opportunities, but it is not a requirement to start investing in commercial real estate.
In summary, commercial real estate investing presents a wealth of opportunities for investors. By applying the same core skills and competencies used in residential real estate, investors can tap into the potential for higher income, long-term cash flow, and portfolio diversification. With proper research, due diligence, and financial planning, anyone can embark on a successful commercial real estate investment journey.
Ready to explore the possibilities in the real estate market? Start by taking our free online real estate investing class and gain valuable insights to begin your investment journey.
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