Investing in commercial real estate is often an exciting and profitable opportunity. Whether you are looking to transition from residential to commercial real estate investments or just looking to diversify your portfolio, you may be curious to learn more about commercial real estate and its potential return on investment. It is easy to feel overwhelmed while searching for commercial real estate investment opportunities, or developing a business plan, but arming yourself with the right knowledge can certainly help ease the process.
Types of Commercial Real Estate Investments
There are many types of commercial properties you can choose to invest in. Apartment complexes, offices, shopping centers, plazas, and recreational centers are just a few examples. Industrial buildings (e.g. warehouses and distribution centers) and multi-unit residential properties that are being leased for profit also count as commercial properties.
How to Determine if Your Commercial Property is a Good Choice for Real Estate Investment
When browsing potential commercial properties, there are many factors to consider. However, your end goal should be to find a property that fulfills your needs and aligns with your investment goals.
One factor to consider is the type of building you are purchasing. Look at the area's demographics to determine what sorts of businesses will generate the highest level of demand. For instance, a healthcare center in an area with a large senior population will likely be more profitable than a similar center in a younger area.
When determining the profitability of a property, it is also wise to consider industry trends. The increase in online shopping since the onset of the pandemic has skyrocketed demand for industrial real estate such as warehouses and distribution centers. Finding a property that can sustain a profitable business ensures a sustainable cash flow for you, the investor.
One quick calculation you can use to help you determine the profitability of your investment is the capitalization rate (cap rate). To calculate a cap rate, you divide your asking price by the yearly net rent. Different markets will have different cap rates. Downtown Toronto will typically have a low cap rate meaning the cash flow is smaller relative to the purchase price. A tertiary market should have a higher cap rate, meaning the cash flow is more significant relative to the purchase price. Many investors that invest in lower cap rate investments are depending on appreciation of the asset as well to offset the lower cash flow per year.
If you are a first-time investor, it is also essential to know what types of buildings may require more experience to invest in. Independent restaurants and bars, for instance, carry a much higher level of risk and have increased failure rates compared to other kinds of commercial properties. It is also wise to avoid investing in properties in areas with high vacancy rates.
Investing in Your Commercial Property: The Pros
Higher Potential Returns
Commercial properties often have higher rents than residential properties. While they also have higher asking prices, most commercial leases are triple net. This absolves you of many risks typically associated with residential leases.
Businesses often make great tenants because they have a personal stake in the quality and state of the property. Sometimes, business owners will even invest in expensive property renovations to better their space, benefitting you once it is time to change tenants.
Commercial property leases are often much longer than residential leases and have reduced turnover rates. This allows you to generate a stable cash flow for a longer period of time.
If you already have investments in residential real estate, investing in commercial real estate can diversify your portfolio, providing alternate cashflows.
Investing in Your Commercial Property: The Cons
When you invest in a commercial property, you put yourself at greater risk of damages. Retail spaces are more commonly broken into, vandalized, or damaged than residential properties.
While commercial properties often generate higher rents than residential properties, the asking price is also more significant. A commercial mortgage will likely require a larger down payment and have higher mortgage interest rates. If you want a more hands-off investment, you will also need to pay a property manager to take care of your investment.
Harder to Find Tenants
While commercial property tenants tend to be more involved and invested in the property's well-being, securing a great tenant can be difficult. You may have to hire a commercial property management company to help you screen potential tenants and find the right match for you.
How do I Buy Commercial Real Estate?
How to Find a Good Listing
When searching for commercial real estate listings, there are many online platforms you can browse. But if you prefer a more personalized approach, there are a few other options you can explore. Meeting with a real-estate agent is one option that can help you answer many of your investment-related questions and allow you to find property showings more easily. Joining a real estate investment club is another great option. You do not need to be an investment expert to join one of these clubs, but member networks and events can introduce you to plenty of people who are. Member networks and databases can be great resources for finding listings in your city of choice.
Putting Down the Mortgage
The down payment, asking price, and mortgage rate of a commercial property will likely require more capital than a residential real estate investment. Because of the higher value of commercial mortgages, the criteria for mortgage approval will also be a lot stricter. Your credit score, source of income, and debt to income ratios will be carefully analyzed. The property itself will also undergo heavy screening. In some cases, you may have to prove and justify the profitability of the business occupying your building in order to establish the stability of your cash flows.
Renovating the Space
When investing in a commercial property, renovation costs can be mitigated through a triple-net lease. However, you still need to ensure that your renovations are properly completed, and that your property meets industry standards. If you have acquired a business tenant, sometimes they will organize the renovations themselves. Either way, it is important to ensure that the hired builders are professional, reputable, and have the required expertise to meet the needs of your building.
Working With Professionals
Working with a professional mortgage broker to explore your options is the best way to determine whether a commercial real estate investment is the right choice for you. Together, you can decide upon the best investment strategy for your unique situation.
If you are looking for expert mortgage advice tailored to your personal needs, schedule a free consultation with a trusted Clover Mortgage broker today!