Most people start their real estate career investing in residential properties. Eventually, they look to commercial investing because it is much more profitable. Before you jump into commercial real estate there is very different information you need and a different approach compared to residential investing.
Six Tips to Get You Started in Commercial Real Estate
- Commercial real estate is valued differently than residential. Residential properties derive their value based on recent comparable sales of similar properties in the neighborhood. Commercial real estate cares little about comparable sales. The value of commercial property is determined based on cash flow. Two buildings, each with 6,000 square feet and located on the same downtown block will have different asking prices. A single tenant small grocery store will have less cash flow than a four-tenant office building for attorneys and CPAs.
- Market and sector knowledge is critical to your success. If you have personal knowledge about a particular commercial sector, stay with that sector. If you have no knowledge about a sector, gain the knowledge you need before investing. Even if you’re only the landlord, you don’t want to invest in a hotel if you don’t know anything about the hospitality industry. Same thing with the manufacturing sector. You don’t want to own an industrial park if you don’t know the best use of the property to maximize cash flow.
- Different formulas are used in commercial real estate investing. Along with sector knowledge, you need to learn new profit and loss formulas before investing in commercial properties. In residential you may have only bought properties for 75% of after repair market value or rentals that cash flowed 20% above expenses. In commercial real estate, you need to understand cap rates, net operating income, loan to value ratios, and other commercial specific formulas. These are not difficult but you need to fully understand what each means and how they affect your profitability.
- Patience is a virtue when investing in commercial real estate. You don’t always want to invest in whatever is currently on the market just because you have the money. First, you want to determine what you want to invest in based on tip 2 above. Next, build a network of professionals involved in the type of investment you want to make. Finally, wait for the right property to come along at the right price based on the formulas in tip 3.
- Consider the long term impacts before investing. Besides the immediate cash flow, you need to understand what is likely to happen to commercial real estate in the surrounding area in the coming years. Is it located in a city where the core infrastructure has been neglected for years? If so, businesses will slowly begin locating elsewhere in the years ahead. Look at things such as a major employer in the area that might be struggling financially and it’s becoming questionable if they will survive. Look at the tax base of the community. Has it consistently been declining along with associated services?
- Don’t put all of your eggs in one basket. If you’ve had success as a residential investor, keep some on your holdings in residential. The commercial and residential sectors don’t always run in the same business cycle. Whether investing in stocks and bonds or real estate, smart investors always strive for a diversified portfolio.
Commercial real estate is a great way to invest to become wealthy and can provide passive income streams for retirement. Following these commercial investing tips and building a strong network greatly increases your chances at success.