The life blood of the commercial real estate industry is investment property. From high-rise office towers in Manhattan to corner market stores in Mansfield to warehouses in Miami, real estate investors own and manage the vast majority of commercial properties throughout the world. Real estate investing has proven over decades, if not centuries, to be one of the best ways to build wealth and create a long term steady income source.
If you are trying to find a home for your existing business or want to become a landlord for other businesses, understanding the commercial real estate industry is key to making sure your investment properties are providing the right return on your capital and effort.
There are many property types to choose from and each has its own very distinct set of benefits and problems associated with property ownership. Office buildings, for example, range from urban to suburban, Class A to Class C, high rise to single story, multi-tenant to single tenant, full service to triple net, and have a wide range in property value. Property value can vary based on all the above criteria as well as the credit rating of the tenants, age and condition of the property, structure of the debt, regulatory restrictions and many other factors. All of the other property types have the same variables so it is important to fully understand what you own, or want to own.
Commercial investment property should be treated as a business. This is where our expertise can help guide you through the choices, answer your questions, provide valuation guidance and maximize your returns on your investments of capital and effort.
Investing in Commercial Real Estate Originally published in Inside Business
Jonathan Commercial Properties
As our stock market continues its uneven skyward climb, many investors are looking for more predictable and stable investment options. Basic real estate has never had the sky rocketing potential compared to the stock of a few stellar companies, but whether commercial or residential, it should be included as part of a balanced investment portfolio, even for the average investor. Banks, insurance companies and institutional investors have always made real estate a standard part of their portfolio mixes because of its steady income and ability to hold its value. It’s time for investors to get back to basics, back to the sticks and bricks that this country was built on.
The benefits of owning real estate include income, equity build up, appreciation and tax shelter. Real estate investments generate “cash flow” or income through the collection of rents. After the property expenses and mortgage are paid there should be a positive “net income” left over that is available to the owners. Investment properties are valued based on this “net income”. Equity build up is the process of paying down the mortgage over time using collected rents. As the mortgage is paid down, the owner’s equity increases and although this money is not immediately available, it can be taken out when a property is sold or refinanced. Each year as rents increase and markets grow, property values increase also, this is appreciation. Appreciation can also come in the form of increased value through making improvements to the property, or having the location go up in value due to outside influences. Tax advantages of owning real estate include sheltering income and depreciation. How these can impact your portfolio depends on your individual assets and would be the topic of a whole separate article and a visit to your accountant.
There are many types of real estate investments available. Residential can include single family rental homes, duplexes, trailer parks and small apartment complexes. Commercial properties include office buildings, retail or shopping centers, industrial buildings, hotels and larger apartment complexes. In addition to these, there is land speculation and a product called Real Estate Investment Trusts (REITs). REITs and land speculation are at opposite ends of the complexity spectrum for the real estate investor. Land speculation takes a great deal of patience and knowledge about the local market, emerging demographic trends, zoning and land development. REITs on the other hand are designed to allow the average investor to have real estate as part of their portfolio without the headaches of buying, managing and selling. REITs are available as shares of stock in groups of properties that are bought, managed and sold by the REIT. REITs provide the protection of a diverse portfolio of properties and the liquidity of owning stocks. REITs don’t give the investor any control over the properties and there are tax implications with REITs that differ from common stocks.
Owning other types of commercial properties have differing levels of complexity and management requirements. Apartment complexes are very popular because they are easy to understand and can sometimes offer higher appreciation benefits than other property types. Apartments can also be much more management intensive. Hotels are considered difficult to manage but can be very profitable if the owner has hotel experience and understands the particular market in which they operate. Office buildings can also be management intensive but can offer reduced risk if there are many different tenants with varied lease expirations. Shopping centers are very popular with investors because they offer triple net leases where the tenants pay all the expenses and the ownership generally has no maintenance responsibility for the interior of the spaces. Industrial buildings usually house small businesses, are therefore quite stable and are also often set up on triple net leases so the ownership has minimal responsibilities. Commercial buildings come in both single and multi-tenant options. Single tenant office, retail and industrial buildings can offer greater income stability if there is a long term lease in place and the owner has an exit strategy for when the lease expires. Single tenant buildings have minimal management requirements but higher risk if a tenant vacates.
The most common investments in commercial real estate are usually properties that are occupied by the owner. For small business owners this is a great personal investment strategy that allows full control of the property and a retirement plan with cash flow. When the mortgage is paid off the cash flow all goes to the owners. Often if the business is sold, part of the deal is continuing to rent the property for a set period of time. Once owners discover the benefits of owning their own buildings and understand the process, they begin to look for addition properties to add to their portfolio.
Real estate has historically been an investment of the wealthy, to provide diversity for their portfolios. Today many small investors are discovering opportunities in real estate as partial owners in larger projects or by rolling up their sleeves and putting in some effort. Either way, basic real estate tends to hold its value because of solid underlying rental income. It’s still the same old story of the turtle and the hare.