The Economist recently reported that investment in residential properties amounted to $ 48 billion, while investment in commercial real estate (CREI) was ‘only’ $ 14 billion. Certainly, this is partly because CREI is much more complex.
Unlike stocks and other such investments, real estate has a strong and very concrete and tangible location. Investors may be many miles apart, but the property exists as part of its own local market, which affects how it is valued, bought, sold and used. And unlike residential properties, commercial property is intended for business purposes. As a result, there are different considerations for valuing, financing, leasing, and maintaining these types of properties.
A commercial investor generally must invest much more in the purchase and sale of the property. You need to be smart and willing to take a higher risk (and consequently get a higher reward).
You will need to know how to calculate the capitalization rate (cap rate) and the gross rent multiplier (GRM). The capitalization rate can be found by dividing a property’s annual net operating income by its purchase price. In the past, an investment with a capitalization rate of 10% was considered a smart financial decision. Recently, however, that number has dropped to 8%, which corresponds to higher risk and lower expected return. To find your GRM, divide the purchase price by the property’s gross monthly operating income.
You should also consider the difference between the appraised and appraised values of a property, and the total income and replacement costs.
Commercial properties are more susceptible to market fluctuations, making them a greater potential risk. Be aware of and sensitive to changes in general economic conditions. A smart investor should always worry about external factors that will affect occupancy rates (domestic and foreign factors alike). Problems around the world can put heavy pressure on US trading conditions overnight.
Investing in commercial properties requires knowledge of local zoning and leasing regulations. Do your research. In addition, you will need to consider other financial issues. The rented properties need heating, cooling, electricity supply, etc. You will need to provide a fire extinguishing and security system. Tenants will also need telephone and Internet services.
Mortgages and insurance are also more complicated than with residential properties. An exception is the triple net lease, in which the tenant is responsible for additional expenses related to the maintenance and repair of the building. In this arrangement, the tenant would also be responsible for the insurance costs.
The risks are many and CREI requires very specific local knowledge, but the reward potential is far greater than owning a residential property. There is also something to be said for the satisfaction one can receive as part of promoting and maintaining our collective economic growth. Entrepreneurial dreams will be made and carried out within your walls, and you should certainly be comfortable with that.