Commercial Real Estate: An Overview for Investors
We all know that the residential real estate market is hot right now, but what about the commercial real estate market? While commercial real estate has seen a ton of ups and downs throughout the past year, it’s safe to say that it’s on an upward swing.
But before you jump in with both feet, it’s a good idea to do your due diligence in terms of research and ensure that you’re making a solid investment.
Commercial Real Estate for Beginners
Commercial real estate, or CRE, is the real estate sector in which property is used for business purposes rather than residential or living purposes. Commercial real estate covers everything from health care facilities to shopping malls to apartment complexes. So if you’re looking to get in on a new business venture, commercial real estate is one area you may want to consider.
Different Types of Commercial Real Estate
While you may view commercial real estate as a monolithic category, it’s much more diverse than you might realize. There are several different types of commercial real estate that you might want to consider investing in, including:
This is the most common type of commercial real estate, and it consists of office spaces for businesses to lease out. Office spaces can range from single-tenant spaces in office parks to thousands of square feet within a skyscraper. Office space leases are typically longer than a traditional residential lease — usually ranging from five to ten years in length.
Office spaces are divided into different lease classes depending on the age and condition of the building:
- Class A includes the newest buildings in the best condition with luxurious amenities. Professional real estate management companies typically manage these types of buildings.
- Class B includes older buildings that are generally well-maintained and managed but may need some capital investment for repairs and upgrades. Investors typically target these types of buildings.
- Class C includes dilapidated older buildings that require extensive upfront costs to repair and effectively lease them out. They may also be located in undesirable areas.
This type of commercial real estate consists of space for companies to conduct business with the general public.
Examples of retail spaces include clothing shops and restaurants housed in anything from strip malls to legitimate shopping malls. These types of leases are generally mid- to long-term ranging from four to five years. The earning potential for retail spaces is mainly dependent on location — with desirable and accessible locations bringing in top dollar.
This type of commercial real estate consists of residential housing made up of four or more separate units. Examples of multifamily spaces include fourplexes, apartment complexes, townhome communities, and condominium complexes. You can have anything from five townhomes in a row to hundreds of apartment units within a multi-story building.
Since these leases are residential, they are typically short-term in nature — usually lasting for about one year.
This type of commercial real estate consists of space designated for industrial business operations that are not public-facing. Examples of industrial spaces include warehouses, manufacturing plants, and research facilities.
These spaces typically come with a lot of square footage and are not located in highly desirable areas. These areas are designated according to “zones” laid out by the local governing authorities. Leases for industrial spaces typically last for at least five years.
Benefits of Investing in Commercial Real Estate
Many people want to get into commercial real estate investing due to its perceived benefits. The main motivation usually comes down to making money. But in reality, there’s so much more to it than that.
Here are just a few of the benefits that you can reap from investing in commercial real estate:
As you’re now aware, most types of commercial real estate involve longer leases. You can expect to have the same tenant for five to ten years if you’re involved in office or industrial real estate. On the other hand, retail typically has shorter leases that can still be worthwhile. Why are longer leases beneficial?
Because longer leases essentially guarantee you a more extended and more secure stream of income in contrast to shorter-term residential leases that only last for a year before you have to scramble to find a new tenant.
Variety and Flexibility
As you now know, there’s so much that you can do with commercial real estate. You can go big and purchase a high-rise office building, or you can go small and purchase a four-unit multifamily building.
The variety of property types in commercial real estate allows you to find areas that interest you and make sense for you. No matter which route you choose, there’s tons of room for success within this field, so long as you do it right.
Believe it or not, there are actually tax benefits to investing in commercial real estate that you should take into account. For instance, there’s depreciation that allows you to deduct a portion of the property’s value from your taxable income each year to effectively reduce your total tax burden.
Additionally, many lenders are pleased to learn that interest expenses are tax deductible. There are also 1031 exchanges that allow you to avoid capital gains taxes when you sell your property so long as you exchange those profits for another property asset when you do sell.
This is just a snapshot of the possible tax benefits of investing in commercial real estate. To explore all of your possible benefits, contact a tax professional.
Another benefit of investing in commercial real estate is that you deal with less competition than residential real estate. Not everyone can afford to pay the higher prices necessary to purchase commercial real estate holdings, for starters. Furthermore, commercial real estate is generally perceived as a more complex investment area, and not everyone is up to the challenge.
Work With Businesses
Investing in commercial real estate may be appealing because you’re working with reputable businesses as tenants rather than individuals with reputable businesses. It may be highly beneficial for your own business to build relationships with your tenants for networking purposes.
Keep a Schedule
Since you’re working with businesses that operate during general business hours, you’re then able to keep a relatively regular schedule as an investor. This contrasts with residential real estate, which requires someone to be on-call 24/7 to deal with any issues.
One of the biggest benefits of investing in commercial real estate is its higher return on investment. You can expect to earn 6 to 12% on your investment in commercial properties.
Meanwhile, single-family residential properties only earn between 1 and 4%. Additionally, commercial real estate properties pose a lower vacancy risk than residential properties do, thanks to longer lease terms.
Guaranteed Cash Flow
Another benefit of longer lease terms translates into more guaranteed cash flow when you invest in commercial real estate. When you multiply this across several units — as is common in commercial real estate properties — you can bring in a lot of cash from a single property.
Finally, many investors build in real estate taxes, property insurance, and maintenance costs into the lease to profit as much money as possible from the holding.
How To Start Investing in Commercial Real Estate
The hardest part of investing in commercial real estate is simply getting started. Many people falsely assume that they can’t possibly invest in commercial real estate without millions of dollars in the bank. However, that’s not the case.
Here’s how you can start investing in commercial real estate:
- Do your research and identify potential areas of investment: Because every market is different, do your research to determine where you want to invest and in what area. From office space in Austin to retail in Miami, the options are endless. No matter which areas and industries you choose, make sure that you are well-versed in this area and are prepared to move forward.
- Understand what’s going on in the market: One common mistake that beginning commercial real estate investors make is jumping the gun. While it’s totally understandable that you want to get started in this exciting new venture as soon as possible, you need to ensure that you’ve done your research first.
Begin by looking at many deals to get a sense of what properties are actually worth. Keep track of deals that close, and talk to others in the industry about their current projects.
While there’s no way to know if you’re buying at the top, it doesn’t matter if you’re creating cash flow. Cash flow is the most important part of investing, and if you gain capital every month, you can hold even when values drop regardless of whether a property appreciates or declines in value.
- Identify potential buildings for purchase based on comparables: Once you have a better idea of what areas you want to invest in, you can start looking for actual properties to purchase.
Before you even make an offer, be sure to research the prices of comparable properties to get a good idea of what the property is worth and what you should offer on it. Also, be sure to take into account repairs and maintenance costs.
- Find a lender and start investing: Once you have identified the ideal commercial property to invest in, it’s time to take action! The right lender will help you do this. You should consider alternative lenders and different loan options like bridge loans to help get you to the closing table quickly. Stay tuned for more information regarding some of the best commercial loan options for investors.
- Identify potential buildings for purchase based on comparables: Once you have a better idea of what areas you want to invest in, you can start looking for actual properties to purchase.
The Current Commercial Real Estate Market
As the COVID-19 pandemic continues into 2022, it’s worthwhile to look at what that means for the commercial real estate market.
Here are some trends and predictions to keep in mind when considering your next moves:
- Hotels, restaurants, and other hospitality services may start to see slow but noticeable growth. In-person meetings are more likely to fuel successful business deals, so hotels will likely see an increase in these specific patrons.
- Buyers should expect to see interest rates climb again. However, this might be helpful for some. Higher interest rates could dissuade other buyers from trying to purchase properties, thereby decreasing the competition.
- Not only will the higher interest rates be unappealing to some buyers, but these rates will also disqualify a notable number of buyers from obtaining loans. Most banks evaluate mortgage requests on a debt-to-income ratio. So, every time interest rates climb, more and more buyers are no longer eligible for the mortgages they would need.
- Supply chain issues have been a point of concern since 2020. Predictions state this will continue to be an issue in 2022.
- Certain industries, like the wedding industry, will experience increased profits as weddings that have been delayed are more likely to proceed as vaccination numbers climb. Individuals are paying higher than usual costs to finally experience their big day.
- The housing supply continues to remain low. As more people are looking to work from home permanently, they are looking to stay in their homes and not sell.
The Best Commercial Real Estate Loans for Investors
Now that you’ve made the decision to invest in commercial real estate, you need to take the next steps to make your dreams a reality.
Unless you have substantial cash assets that you don’t mind shelling out to purchase a commercial property, you will need to use a loan. The good news is that there are several different types of loans that you can use to purchase commercial real estate.
For instance, there are commercial bridge loans, commercial blanket loans, commercial balloon loans, commercial construction loans, commercial hard money loans, and interest-only loans.
Let’s explore each of these options in greater detail so that you can make the best investment decision:
1. Conventional Commercial Loans
The first type of commercial loan investors should consider using is a conventional commercial loan. Like a residential mortgage loan, conventional commercial loans have a long term and a fixed interest rate. These terms are usually shorter than residential loans, usually ranging from five to 10 years. Interest rates range from 4% to 7%, with a minimum 25% down payment.
There are two types of conventional commercial mortgages, amortized or interest-only. For an amortized loan, the borrower will make regularly scheduled payments that go towards both the principal and interest.
Interest-only loans, as the name suggests, only require the borrower to make payments that go towards the interest for some or all of their loan term. The borrower can pay off their principal payment as a lump sum at the end of their term, or they can amortize their payments after a set period of time.
Both amortized and interest-only conventional commercial mortgages will have lower interest rates, higher loan limits, and more options for down payments and term lengths. However, these loans are also the hardest loans to qualify for, and the process could take between 30 and 90 days.
2. Commercial Bridge Loans
The second type of should consider using is a commercial hard money loan should consider using is a commercial hard money loan investors should consider using is a commercial bridge loan. A commercial bridge loan provides investors with the quick financing they need to make a competitive offer on a commercial property. If a borrower wants to close quickly, they can use a bridge lender before refinancing with a lower rate later on.
Commercial bridge loans are temporary financing solutions with terms that typically last anywhere between 12 to 36 months. During this time, you should secure a permanent financing solution that then covers the remaining balance of the loan based on principal and accrued interest. Commercial bridge loans interest typically falls from 7 to 10%, depending on your qualifications.
3. Commercial Blanket Loans
The third type of commercial loan investors should consider using is a commercial blanket loan. A commercial blanket loan provides investors with multiple commercial properties the option to roll these different properties with different mortgages into a single loan with a single payment. A single payment makes managing your properties and payments much easier as an investor.
One of the positive aspects of a blanket loan is the use of cross-collateralization. With cross-collateralization, you can take one asset and use it as collateral for multiple loans. This can be a great option for commercial real estate buyers. Cross-collateralization is usually not utilized in the realm of residential mortgages.
4. Commercial Balloon Loans
The fourth type of commercial loan investors should consider using is a commercial balloon loan. A commercial balloon loan allows investors to make lower monthly payments by only having to pay the interest throughout the term of the loan before making a large “balloon” payment at the end to cover the remaining balance.
A commercial balloon loan is a good option for businesses that aren’t quite up and running yet — since you’re able to make low monthly payments before making one large payment when you hopefully have the capital to do so. Commercial balloon loans allow you to only pay on the accrued interest each month before your final payment.
5. Commercial Construction Loans
The fifth type of commercial loan investors should consider using is a commercial construction loan. A commercial construction loan provides investors with the funds they need to actually construct a commercial property rather than buying one that’s already built. This is a great option if you’ve found the perfect plot of land for your office building, apartment complex, retail space, etc.
That being said, commercial construction loans typically come with shorter terms of less than 36 months. As a result, you need to be prepared to pay back the loan quicker than some of the other options discussed here. Additionally, you need to consider the interest rates of commercial construction loans that typically fall between 5 and 10%.
Unlike other commercial loans, construction loans function more like a credit line. Borrowers are not required to pay interest until they have withdrawn the money, at which point they are charged monthly interest that typically accrues until the project is completed.
6. Commercial Hard Money Loans
The sixth and final type of commercial loan investors should consider using is a commercial hard money loan. A hard money loan provides investors with quick and easy access to the funds they need to either purchase or renovate a commercial property — at a cost.
Hard money loans come with some of the highest interest rates in the business — ranging from 10 to 18%, depending on your qualifications. They can also provide credit lines for renovation costs.
Hard money loans come with high interest rates because they are seen as risky investments. These loans often don’t have very strict requirements or qualifications. Although this makes them accessible to nontraditional borrowers, it also means that you can end up spending thousands and thousands of dollars on interest.
As a result, a hard money loan should only be used when you’re able to pay it off in a timely manner to avoid racking up a lot of interest.
How To Get a Commercial Real Estate Loan
If you’ve previously applied for and received a residential mortgage loan, you may think that the commercial loan process is essentially the same. And while buying a home can certainly prepare you for buying a commercial property, the two processes are quite different. Here’s what you need to know about how to get a commercial real estate loan:
- First of all, you need to decide which type of commercial real estate loan you want. This is because not all lenders offer every type of loan.
- Once you know what type of loan you want, you can begin to look for lenders who offer this type of loan product. Oftentimes, the best place to look for lenders is online since it provides you with a whole host of information about the lender’s offerings and terms.
- From there, you should reach out to a few different lenders to see if you’re qualified and determine how much they will charge you in interest. Generally speaking, you should choose the lender that offers the best overall terms and interest rates.
- Once you have chosen your lender, you need to complete the formal application. This process will be more detailed than the one you completed to “pre-qualify” and get your interest rate. Be prepared to provide the lender with a whole host of documentation showcasing your financial stability and the performance of the asset.
Many lenders require things like income tax returns, W-2s, 1099s, pay stubs, bank statements, investment account statements, etc. The lender will also run your credit report to ensure that you have a solid credit history with no red flags like bankruptcies or defaults.
They will also need to see financials for the business/property. This may include the lease revenue, expenses, business operating financial statements. It's also important for the lender to be aware of any environmental issues or recent improvements on the commercial property.
After your application has been processed, you will either be approved or denied. If you are approved, you then sign the final documents, close on your loan, and finally move forward with purchasing your commercial property — congratulations!
Depending on your responsiveness and the speed of the lender, this process can take anywhere from a few days to a few weeks. However, with the speed of the commercial real estate market, you need to keep up with the competition by choosing a lender like Vaster that will get you to the closing table as quickly as possible.
Final Thoughts on Commercial Real Estate
As you can see, the time to start investing in commercial real estate is now. Timing the market is nearly impossible, and you can get in before everything starts to heat up again while interest rates are still low.
Understandably, this is an intimidating and exciting journey — one that you’ll need support on to find success. You can find incredible support from a responsive, reputable, and trustworthy lender like Vaster.
Always feel free to reach out to us with all of your commercial real estate questions for professional advice and expertise.
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