Commercial real estate 101: is it worth investing in?

Commercial real estate sounds appealing to investors because it comes with high returns, passive gains, and big growth potential. It’s a popular alternative investment. Appreciation and income are the two main ways commercial real estate agents earn money. Commercial real estate increases over time, while the constant operation of the building produces income.

What makes commercial real estate challenging? It requires more money, time, and expertise than traditional real estate.

The largest categories of commercial real estate

Before explaining what the largest categories of commercial real estate are, it’s important for you to correctly identify the properties that fall under this category. Commercial real estate includes properties that aren’t residential and produce income through leases. It’s a broad term people use to refer to properties that generate profit.

Here are the largest categories of commercial real estate

Retail

Retail properties are usually located in urban areas and include restaurants, grocery stores, bars, shopping malls, and even banks. Unsurprisingly, the above businesses don’t buy spaces, they prefer to rent them because it’s easier to relocate if the venture doesn’t turn profitable.

Office buildings

Most commercial real estate is used for offices. Companies prefer large buildings that can accommodate hundreds of employees. When investing in office buildings, you should identify what category of buildings is the most successful one in your region. Office buildings can be Class A, Class B or Class C.

Class A buildings are located in prime areas and they have easy access to essential amenities. They usually are newly-built or renovated constructions large companies prefer. Owning this type of building is profitable because corporations usually occupy the same building long term.

Class B buildings require renovations before listing them for lease or rent. They usually require fewer reparations than Class C buildings, and corporations also target them for office space.

Class C properties need extended renovations and their location doesn’t provide easy access to essential amenities. When finding a cheap deal, you should check if companies are interested to rent in this area. There’s no reason to invest in a building, corporations don’t find suitable to rent. Most of Class C buildings need new insulation, new windows and doors, new wall paint, and new installation. If you intend to keep the old water pump running, it probably needs motor repair, a job you can’t do on your own.

Hotels

It’s worth investing in a space you can transform into a hotel. Business hotels, resorts and motels are part of this category. If you intend to list your house on a renting platform you should know this category doesn’t include Airbnbs.

Industrial

This category includes warehouses, factories and any other building businesses use. The good part about buildings used for industrial purposes is that their location isn’t important. Usually companies prefer to set their factories and warehouses near a town or in its suburbs.

Other categories of commercial real estate include hospitals, schools, non-profits, special purposes, and multifamily.

Should you invest in commercial real estate?

Entrepreneurs choose to invest in commercial real estate because it brings higher returns. Studies show that the annual return on commercial investments is between 5% and 10%, depending on the area where the building is located. The return rate also varies according to the type of building you own. A residential building usually brings from 1% to 5% annual return.

If you rent your space to a business, you have professional tenants, and they are more likely to spend more to maintain the property because they take pride in their headquarters. They will ensure they clean and protect the building because its look directly influences their success.

As stated before, companies are the main tenants for commercial properties and they prefer to rent spaces in the long term. The average corporation rents a space for at least 5 years. It’s worth to renovate a space a tenant rents for more than 5 years because it generates profit to cover your investment and to make a profit. When the terms are favourable, companies choose to rent spaces for over 10 years.

What holds you back?

Commercial real estate has both pros and cons. To help you decide if it’s worth investing in this domain, you need to know what can hold you back. When you rent the space to multiple tenants you spend more time managing the process than when you perform a residential investment. To maximise the return on your investment you need to be a present landlord. You not only that deal with multiple tenants, but you also have to perform common area maintenance and deal with public safety concerns.

Because corporations pay more than residents to rent a space, they expect you to maintain the property in top-notch conditions. This job is costly, especially if you don’t have the skills to do the job.

And last but not least, commercial real estate requires a higher initial investment because you need to renovate a larger space. When renovating it you need to consider the requirements of the future tenant because each company comes with its requests.

Various ways to invest in commercial real estate

You can choose from multiple options if you want to invest in commercial properties.

The simplest way to operate a commercial building is to have the outright ownership of the space. If your budget allows, and you identify a building located in a profitable are, then you should purchase it. Commercial properties are great investments because they produce regular income. Ensure that your time allows you to manage the investment because being the landlord of commercial space isn’t an easy task.

Another solution is to buy debt or an equity stake in commercial real estate. This implies you pooling funds in an LLC. It’s a more affordable option than the first one, but still requires a large investment.

Real estate crowdfunding is an effective way to invest in commercial properties. It’s great because it allows you to invest a small sum. Most of the projects allow investors to participate with as little as $500.

This is what you need to know before investing in commercial real estate.