The Fundamentals of CRE Investing

Investing in commercial real estate sounds like an attractive option to many, but starting out in CRE investing can seem daunting and overwhelming. There are several factors to consider, from finding and securing financing to picking the right location, and formulating a business strategy that maximizes the asset’s value. These fundamentals of CRE investing will help set your foundation.

There are many advantages that come with owning commercial real estate. For instance, investors can benefit from deducting interest payments from their taxes and deferring capital gains. There can also be a lot of risks associated with macroeconomic trends of local migration patterns and natural disasters that can impact an investment. 

Let us take a fundamental overview of commercial real estate investing, and offer some ways investors can find profitable opportunities during each phase of the market cycle. 

Benefits of Investing in CRE

Commercial real estate offers investors several benefits beyond the allure of financial gains. The asset class is known for creating stable cash flow, asset appreciation, tax benefits, and opportunities to use leveraged funds to grow an investor’s portfolio. Some of these benefits are easy to see, while others require some digging. 

Commercial properties can generate stable cash flows because leases are often between three and five years. These deals are also usually structured to give investors predictable monthly, quarterly, semi-annually, or annual returns. 

Commercial assets have also historically outperformed other investments like stocks. Research from commercial brokerage Marcus & Millichap found that commercial assets have appreciated at a combined average growth rate of 7.8% since 2000 compared to the S&P 500’s 5.3% growth rate. 

There are also lucrative tax benefits to commercial real estate, such as depreciation and interest deductions on mortgage payments and deferring capital gains. These benefits can significantly reduce an investor’s overall tax liability.  

Leveraged funds also give investors opportunities to achieve higher returns on equity and can also reduce an investor’s tax liability since interest paid on loans is tax deductible. 

Initiating your CRE investment journey

There are five steps to begin investing in commercial real estate: Learning about commercial real estate, Defining goals and strategies, Networking, Finding financing, and Scouting the market. 

1. Learning about commercial real estate. Spend time learning about the different product types, investment strategies, and how to conduct a thorough market analysis. 
2. Define your goals and strategy. Once you have learned the basics, identify measurable goals and back them up with strategies to achieve your desired results. Two of the most important metrics to identify are the success or failure points of an investment. 
3. Networking. Your network can be the difference between identifying an emerging opportunity and investing in a dying submarket. 
4. Locate and secure financing. Finding the right kind of financing can make or break a deal. Exhaust all potential options before deciding on a particular path. In the early stages, use caution as to not act upon financing that may be too risky or expensive simply because your excitement level is high.
5. Scout the market. Use the network you’ve built to find good deals. Conduct thorough due diligence before investing in a property. 

Types of CRE investment

There are three main types of commercial investments: direct ownership, crowdfunding, and through real estate investment trusts (REITs).

Direct ownership investments involve purchasing a building outright, either as an individual investor, or with a group. This approach requires investors to retain a lot of risk regarding due diligence and creating a solid business plan for the property. 

Crowdfunding occurs when a large number of investors who contribute small amounts collectively pool their funds and purchase a property. This strategy is good for investors with lower risk appetites because the property’s operations and maintenance is usually managed by a third party. 

Real Estate Investment Trusts (REIT) are a form of passive investing where investors give money to a specialized company that buys, sells, and manages assets. Investors are paid dividends from the assets’ cash flow. REITs can also provide significant tax benefits for investors such as deferring estimates taxes on distributions. 

Risk factors

Investing in commercial real estate is not without risk, despite its multitude of benefits. There are market-level risks like local GDP rates, which can impact vacancy levels. Property-level risks include poor construction, a disastrous tenancy, and damage from natural disasters. Investors also face financial risks from interest rates, changing capital markets, and inflation. Investors should understand how each risk could impact their investment and develop a strategy to mitigate any negative impacts. 

Financing options for CRE

Investors generally seek money from two sources: hard and soft money lenders. 

Hard money lenders can be wealthy individuals or investment companies. These lenders are often referred to as “lenders of last resort” because they offer short-term loans like bridge loans but at a higher interest rate than more traditional lenders. 

Soft money lenders are banks, credit unions, and other financial institutions that offer standard long-term financing options like a 30-year fixed mortgage. This approach requires more underwriting during the transaction, but investors usually receive lower interest rates than hard money loans.  

The role of location in CRE investment success

Location is the first factor savvy commercial investors consider when they invest in a new building. It determines a building’s demand, value, and overall profitability. Finding the right location is as much an art as it is a science. 

Retail businesses like restaurants, shops, and merchandisers need high-density areas with lots of foot traffic to survive. That’s why many retail investors prioritize properties along busy streets with walkable amenities. Industrial investors often look at properties located with convenient access to main highways because their tenants need it to move their products. Office investors look for properties that are accessible and convenient for workers, typically long mass transit lines with local amenities. These are all factors investors consider when determining whether a building is well located. 

CRE investment & economic cycles

The real estate cycle generally follows a pattern of recovery, expansion, hyper-supply, and recession. Each phase can present investors with different opportunities.

The recovery phase is sometimes referred to as the bottom of the well. It’s when there is no more construction activity, leasing activity is depressed, vacancies climb, and rents either plateau or fall. This phase might present opportunities for investors to buy distressed properties at a bargain price. 

Expansion happens when demand starts to improve, thereby producing an upward trend of construction activity and rents. Investors might want to consider redeveloping properties during this phase because growing demand support future asset appreciation. 

Hyper-supply occurs when the market is oversaturated and demand starts to fall. Many investors will opt to sell their properties, or start offering concessions to tenants. 

Recessions are easy to spot. Rent growth falls below the inflation rate; vacancies are up; property values are down. Investors may look for deals from financial services and banks that have acquired distressed properties. 

FAQs

What is CRE investing?

Commercial real estate investing is the buying and selling of business properties with the intention of leasing them to tenants for a profit. 

How do I start investing in CRE?

Investing in commercial real estate starts by preparing your finances and learning about the local market. That means formulating a strategy, conducting due diligence and market research, and managing the risks associated with purchasing a particular asset. 

Is CRE a good investment?

Commercial real estate investing has a long track record of providing investors with steady cash flows and asset appreciation, but returns on cash and equity are not guaranteed. Investors need to diligently monitor their asset’s performance and respond accordingly to changes in the market. 

What is the minimum CRE investment?

Some online investment platforms allow investors to purchase a share of a building for as little as $10. Managed funds sometimes require minimum investments of between $10,000 and $25,000. For investors looking to mortgage a commercial property, they could be required to pay a down payment of $100,000 or more. 

Conclusion

Investing in commercial real estate can provide steady returns for investors who carefully manage the multitude of risks associated with the asset class. Conducting thorough due diligence and market research before buying a property is the first key to success. Investors also need to formulate a strategy that will allow them to maximize their returns.