Whether you need a building for your business or want to diversify your investments, purchasing commercial property can be a smart financial decision. However, it isn’t as simple as buying a home.
Commercial properties come with different lending requirements and closing timelines. And despite real estate’s reputation for reliably appreciating in value, they aren’t risk-free investments either.
What is Commercial Real Estate?
Commercial real estate is a broad term that can apply to the following:
- Multi-family residential properties
- Office buildings
- Factories and warehouses
- Retail space
- Hotels and restaurants
- Campgrounds, golf courses and other outdoor recreation sites
Lenders generally consider residential properties with one to four units to be single-family while those with five or more units are multi-family.
Why Invest in Commercial Real Estate?
Savvy investors know diversification is a cornerstone of wealth-building. Spreading money across a variety of assets means there is less risk of losses should one type of investment do poorly. Real estate has a proven record of returns, and investors may also use it as an inflation hedge and for its tax advantages.
“Some people buy for cash flow and some buy for appreciation,” says Nelya Calev, a real estate broker with John L. Scott Real Estate in Bellevue, Washington.
Those interested in cash flow purchase property with the expectation of receiving a steady stream of income from rent payments or other revenue. Those who buy with appreciation in mind want to add to their portfolio property that will grow in value.
“I don’t like to buy for appreciation,” Calev says.
While it’s true that real estate generally appreciates in value, there are no guarantees that will always be the case. Instead, she prefers to find multi-family residential properties where there’s an opportunity to add value and increase ongoing cash flow from rents.
3 Ways To Buy Commercial Real Estate
Buying commercial real estate can be a complex process, but online platforms are making these investments more accessible. Here are three common ways to buy commercial property.
1. Purchase Property Yourself
You could put in an offer to purchase commercial property that’s for sale, but financing may be difficult to obtain if you don’t already have a successful business. Banks require more money down for commercial real estate loans and are likely to scrutinize applications closely. It’s not unusual to be asked to provide a resume and business plan along with your loan application.
If you’re new to commercial property, experts advise investors to consider starting out with a one- to four-unit residential property. Since these are treated as single-family properties by lenders, it can be easier to receive a mortgage for their purchase. Once you have experience purchasing and managing several smaller residential properties, banks may be more likely to approve loans for larger properties.
2. Find a Partner
Finding an experienced business partner is another way to break into commercial real estate. If you aren’t interested in helping to oversee projects, look into becoming a silent partner. Silent partners aren’t involved in management decisions, and their liability may be limited to their investment amount.
Family, friends and business contacts may all be ways to find a partner. You can also search for real estate investors or investment clubs in your area. In addition to being a good place to network with other investors, most offer educational resources to help members be successful.
However you find a business partner, be sure to thoroughly vet the person before entering into a deal with them.
3. Invest in Real Estate Syndication
Real estate syndication is a way to purchase commercial property with a group of investors. A syndicator or sponsor is responsible for all the hands-on aspects of the purchase—from finding a property to negotiating its sale to working with a property management company. Investors provide cash in exchange for ownership shares in the property.
There can be significant bonuses and fees paid out early in a deal to the syndicator while investors don’t receive income until later. However, it can be a good option for someone who wants a hassle-free way to own commercial real estate.
Online crowdfunding platforms—CrowdStreet and RealtyMogul, for example—make it easy to find real estate syndication deals, but you’ll need to be an accredited investor to participate. For non-finance professionals, that means having a net worth of at least $1 million, excluding a primary residence, or an income of more than $200,000 per year for at least two years. The income requirement is $300,000 for those with a spouse or partner.
Some real estate crowdfunding platforms, such as Fundrise, are open to non-accredited investors. But on these sites, you’ll buy shares in a real estate fund rather than receive a share of ownership in a specific property.
Benefits of Owning Commercial Real Estate
Owning commercial real estate can make sense as both a business purchase and an investment in the following ways:
- Equity: Since real estate typically appreciates in value, you can expect property to build equity over time. That equity can be converted to cash by selling the property, or leveraged to finance other investments or business purchases.
- Passive income: Depending on the property, commercial real estate can provide steady income in the form of rent payments from tenants. Even owners who buy property for their own business’s use might be able to earn passive income if they are able to lease out a portion of their space to another company.
- Diversification: Real estate may perform well at times when other investments falter. And even if the value of real estate were to decline, they may still provide reliable passive income from renters.
Downsides of Buying Commercial Real Estate
The benefits of purchasing commercial real estate must be weighed carefully against potential drawbacks.
- Barriers to entry: Banks often treat commercial real estate loans the same as business loans, and only those with an adequate business plan, revenues and financial resources are likely to be approved. It’s likely that some banks may require up to 40% down on commercial buildings.
- Liquidity: While real estate is a valuable asset, it can’t be quickly converted to cash if needed. Instead, a buyer will need to be found, and the process of closing a sale can drag on for months. Closing can range from a couple to several months.
- Additional costs: Owning property of any kind comes with taxes and maintenance expenses. What’s more, investors should expect that it will take 12 to 18 months for a property to stabilize and provide predictable income after a sale.
Some of these disadvantages may be offset by tax breaks, such as deductions for depreciation. Others may be resolved by using real estate syndication rather than buying an individual property outright. But you won’t know for sure until you sit down and run the numbers on your expected costs and return on investment.
To ensure you make a smart decision, assemble a team of professionals to assist you both before and after the purchase. These individuals should include at least an experienced real estate broker, attorney, accountant or financial planner and property manager.
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