For new commercial real estate investors, buying or investing in a commercial property for the first time can be daunting. When buying commercial property, it’s important to have a clear idea of your goals to understand which property is best for you and how to create an excellent acquisition process.
In this article, we’ll lay out the benefits of moving from residential to commercial property, how to buy a commercial property, and the challenges you might encounter along the way.
Why Invest in Commercial Real Estate?
There are many reasons to buy a commercial property, no matter if you’re a small or large investor. Some people buy commercial real estate for personal use. For instance, an investor might buy into a restaurant space and run the restaurant themselves.
Others buy commercial real estate simply for investment purposes. A limited partnership, in which the limited partner simply invests in the property but does not help with operation or business decisions, is one example of buying into commercial real estate solely for investment purposes.
Adam Rosencranz, Chief Investment Officer at Christina, a real estate investment firm focusing on CRE properties in Los Angeles, also pointed out that there are significant tax benefits that come along with owning commercial real estate. There are depreciation allowances and deductions that allow for considerable tax savings, Rosencranz said.
Rosencranz also noted that buying commercial property is a way for investors to diversify their portfolios from stocks and bonds, and it can also be a hedge against inflation.
Trevor T. Calton, President at Evergreen Capital Advisors, echoed Rosencranz’s sentiments, specifically when it comes to hedging against inflation.
“Because rents typically go up when prices go up, somebody who invests in commercial real estate can create wealth that’s commensurate with the rate of inflation, or at least correlated,” Calton explained.
What to Consider When Buying Commercial Property to Rent Out
When buying commercial property to rent out, ask yourself these questions:
- What type of property is best for you?
- What kind of investing do you want to participate in (passive, active, etc.)?
- What can you afford?
- Are you investing alone or with others?
- How much development is necessary on the property?
- What are the dynamics from a land use perspective?
- What are the zoning constraints?
- How will you finance the property?
It’s always a good idea to talk to a CRE expert before making any decisions, especially if you’re new to commercial real estate.
How to Buy a Commercial Property
Here’s a step-by-step guide that explains exactly how to buy commercial real estate.
1. Assess Your Goals
When buying commercial property, the first thing potential property owners should do, Calton said, is assess their goals. Commercial real estate investors should have a specific reason why they’re investing in CRE, whether it be to create cash flow, appreciation, etc.
Understanding your own goals will help determine what type of commercial real estate is best for your needs.
2. Research the Market
The second step, once you’ve determined your goals, is to research the commercial real estate market in your area. The best way to do this, Calton said, is to hire a broker who specializes in whatever type of property you’re looking for.
“That’s really important because a lot of people don’t understand that the whole process of buying commercial is different than residential,” Calton said. “And I see so many first-time investors hire the same agent that sold them their house to help them buy a commercial property because even the real estate agent who has never done a commercial deal doesn’t know how difficult it is.”
The type of CRE pro who helps with this process is usually called an investment sales broker. A debt broker, on the other hand, will assist with financing, although they often provide investment sales brokerage services as well.
If you want to conduct some of your own research before meeting with a broker, try at least one of these sites:
These sites will give you an idea about the commercial real estate buying process and what buying a building could potentially cost.
3. Look for a Property
The next step after hiring a broker is to look for a property, Rosencranz said. When looking at specific sites, you should think about how the building operates and what the potential use of that building might be.
Consider getting an independent appraisal to help assess costs and value.
4. Make an Offer and Acquire Financing
Once you’ve found a site that meets your needs, the next step is to make an offer. For this step, your broker can help, but it’s also a good idea to talk to a financial advisor to get a clear idea of what you can afford.
At this point, you also want to acquire financing for your commercial property through a bank loan or other type of loan. Again, a financial advisor can help with the ins and outs of this process.
Once the offer is accepted, you then need to make sure to complete all of the inspections, review the books and records, do a title search, etc, Calton advised.
Options for Buying Commercial Property with Little Money
For people with little money, there are still options available for investing in commercial real estate. For starters, investing in secondary or tertiary markets will have less of a barrier than primary markets, as real estate in those markets goes for less money, Rosencranz said.
“For instance, if you’re investing in the west side of LA, you’re going to need significantly greater capital in order to do so, just given that the property values are relatively high,” Rosencranz explained. “But if you’re investing in Norman, Oklahoma, or if you want to do Boise, Idaho, property values are not nearly as high.”
Rosencranz also suggested owner-occupied financing. Investors can buy a duplex, for instance, and live in one unit while renting out another. In this scenario, investors can get more attractive financing options.
Calton also suggested partnering with others, like friends or family, to buy a commercial property.
CRE investors can also try to invest in multiple deals through a portfolio, Rosencranz added. Recently there has been more crowdfunded investments, such as Crowd Street, where investors can put in something like $50,000 and buy into a piece of property instead of buying a whole property outright.
There have also been opportunities to buy shares of commercial real estate properties for as little as $250 through single-building stocks. The real estate investment platform known as LEX is turning several commercial buildings into publicly traded stocks.
What Type of Commercial Property Is Most Profitable?
Determining what type of commercial property is most profitable really depends on the market and risk factors that go into it. How much is a person investing? What does the market for that type of property look like at this time?
According to both Calton and Rosencranz, there really is no one answer or what type of commercial property is most profitable.
“There is risk and reward,” said Calton. “So the higher the risk on any given investment, the higher the market is going to expect the returns to be.”
Both Calton and Rosencranz agree that development projects tend to be the most profitable but also the most difficult. Development is high risk, high reward.
However, for new investors, there are safer, more stable investment options, which are not necessarily the most profitable, but they are more likely to return a profit. Calton and Rosencranz both recommended multifamily properties as good investment options for newer investors. Multifamily properties are often viewed as the most stable and easy to understand.
“I don’t think that always seeking out the most profitable investment types are suitable for individual investors because that often requires them to take on a higher degree of risk,” Rosencranz argued, “which is why people who are making their first foray into real estate investing typically invest in a multifamily apartment”
Calton added, “For your average investor, the best risk-reward ratio — the most profitable based on the amount of risk that somebody is taking — would be investing in apartments.”
Buying Commercial Real Estate Can Be a Great Investment Opportunity
Investing in or buying commercial real estate has a number of benefits. Above all, though, it’s essential to understand your goals and finances to make the right decision for you. Make sure to talk to the right experts, hire a broker who understands your specific needs, and speak to a financial advisor who can outline your financing options and what’s best for you.