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Commercial Real Estate Fundamentals for Successful Investors

Alina Trigub
10 min read
Commercial Real Estate Fundamentals for Successful Investors

Commercial real estate always was and probably always will Being successful in commercial real estate takes more than just initiative. It takes time; money; relationship building with brokers, real estate attorneys, and insurance agents; and most importantly, an ability to cold call and write letters to find prime properties for a possible purchase. To build wealth investing in commercial real estate, you’ll need to equip yourself with the commercial real estate fundamentals that successful investors use.be a good type of long-term investment — especially multifamily housing, like apartment complexes. But it does need to be done properly and there are barriers that must be overcome in the process in order to succeed.

What Is Commercial Real Estate Investing?

Commercial real estate investing is when you purchase properties that are intended for commercial businesses and you plan to earn rental income, such as:

  • Office buildings.
  • Industrial properties or warehouses.
  • Retail buildings, like strip malls or shopping malls.
  • Multifamily housing, like apartment buildings.
  • Self-storage facilities.
  • Hotels.

Another commercial property investment option to consider is mixed-use commercial properties, which combine two or more types of commercial use into one building or development, like a building with shops on the first floor and residential real estate with tenants above. These properties can earn you money when you rent them to tenants.

It’s important to keep in mind that investing in commercial real estate is not a “quick fix” to wealth. Although when done properly, it can lead to a lifetime of stable income for an individual and their family, acting as a kind of passive income. A good commercial real estate investment can and should provide enough financial gains to eventually cover the initial investment and allow for continued monthly income. For success, you’ll need to know the eight commercial real estate fundamentals that investors use.

8 Fundamentals of Commercial Real Estate Investing

As with any investment strategy, when you have the commercial real estate fundamentals mastered, you’ll be better prepared for gaining wealth through commercial real estate investing. These are the nine fundamentals of commercial real estate investing that you need to know before you invest:

1. Finding the right strategy for commercial real estate investing

The real estate market — especially the commercial one — can rise and fall sharply within months. There are times to buy and times to withhold a purchase. This is key to finding the right strategy for commercial real estate investing. 

Luckily, these statistics are readily available online by the National Association of Realtors (NAR) and are updated regularly. Because these market fluctuations can be very impactful on the price of commercial property and its overall stability in future years, investors need to be aware of market trends when dialing in their investing strategy. Consider these tips when creating your commercial real estate investing plan:

  • Follow commercial trends closely: This will help you learn to better predict which types of properties will be sought after so you get the best bang for your buck and increase your success. Always be on the lookout for new vacancies and use commercial trends to determine prices for rents.
  • Research and know the geographic area where you are seeking to invest: The geographic area can play a large part in the cost of the commercial property and the amount of rent you can charge as well as the type of potential tenants you’ll get. This, of course, affects the bottom line of every investor, and if you have a certain budget that you must work within, it is wise to find a geographic area that fits your budget.
  • Keep in mind the cost of living in the area: When researching where to purchase, the cost of living expenses for the geographic area is a good indicator of the amount of investment needed before considering a purchase. Certain geographic areas simply have higher costs of living overall, and housing prices can vary tremendously, which will affect your rent prices.

2. Investing in commercial properties

Before you invest in commercial properties, you should create an investment plan and determine your financial and investment goals. From there, you can decide how much of your portfolio you want to be in commercial real estate. Understanding your net worth and your risk tolerance will help you split your investment portfolio in a way that fits your plan. Knowing the commercial real estate fundamentals makes it easier to decide how much of your money you want to invest in commercial real estate.

It’s important to look at how the commercial real estate you own plays into the overall profit picture years down the road. Closing costs and needed repairs to the property in question should be factored in as well as expenses for maintenance and upkeep so that you get a clear picture of what to expect not just following the purchase but well into the future, especially if you plan to hold the property for income for years to come.

3. Multifamily investing

Multifamily properties are those that are intended for more than one family to live in and comprise individual units for each family with separate living quarters, such as apartment buildings. These types of properties can be quite lucrative, as many families are paying rent to you at once. Of course, with multifamily investment properties, you’ll also have higher expenses than you would with single-family. There are many pros and cons to purchasing multifamily dwellings over single-family units, but you need to know what they are if you want to find success with multifamily investing.

Some of the benefits of multifamily investing for commercial real estate investors include:

  • Large cash flow.
  • Passive income.
  • Tax benefits.
  • Scalability.
  • Easy for property management.

The challenges that come along with investing in multifamily properties include:

  • More expensive upfront.
  • Lower appreciation.
  • Hard for new investors to enter the market.

4. Long-term triple-net leased properties

Long-term triple-net lease properties are an excellent deal if you can find them. With a triple-net lease, the tenant at your commercial property has agreed to pay all costs associated with the property, including utilities, insurance, maintenance, and taxes. If you can get these agreements with long-term tenants, you’ll pay less overhead for the duration of the lease.

It’s a good idea to check on these properties occasionally to ensure that tenants are doing the maintenance they’ve agreed to, but many of these tenants can help you save money on certain aspects of maintaining a commercial real estate property.

5. Understanding the fundamentals of commercial property financing

Being able to qualify for commercial real estate financing based on your balance sheet can be a challenge. Balance sheets will vary significantly from one investor to the next. A good balance sheet will show a steady income, healthy cash flow, and budget knowledge. It can include but is not limited to:

  • Profit and loss statements.
  • Stocks and bonds held.
  • Investment properties owned.
  • Various other short- and long-term investments.
  • Proof of the ability to pay mortgages over extended time periods.

To take on real estate debt for a commercial property, you have to prove to the bank that you understand the fundamentals of commercial real estate. The potential investor wants to see how the property is going to make a profit and how it might appreciate over time. They’ll take market conditions into account as well as the overall condition of the property and its location. If you know what they’re looking for, you can choose a property that looks appealing and meets the right criteria to qualify for the investment capital you’re after.

6. Financial analysis review

A financial analysis review is necessary if you want to understand how a commercial property will provide the income you need to make it a worthwhile investment. When considering your initial financial outlays, such as the down payment, the closing costs, and the renovation fees, you need to add the liquidity aspect to the equation before considering a purchase or making an offer on a commercial property.

Liquidity is defined as the ability to turn assets into cash as quickly as possible. Investors should always have enough liquidity to cover at least the down payment, closing costs, and any renovation fees that might be needed, but this will vary from commercial property to commercial property. Any other assets should also be able to be liquefied quickly. Too many assets that are tied up and not easily liquefied can work against investors who want to purchase commercial real estate.

Once you know whether you have the liquidity to cover the down payment, closing costs, and other fees, you can review the overall purchase price of the property and how much you can charge for rent. These are important numbers for your bottom line, as it tells you how long it will be before the investment becomes profitable. Your financial analysis should also look at the expenses to run the building and pay for property management services. 

The figures on your financial analysis will tell you whether a commercial property is a good investment.

7. Managing properties

Hiring a well-positioned property management company can help new investors overcome the challenges they’ll face in commercial property ownership. A property management company with enough experience can serve as a good backup to your own lack of prior commercial real estate experience. Hiring a reputable company means you’ll have people with a lot of knowledge in the industry to help you navigate being a commercial property owner.

They’ll have answers to your questions when you’re struggling, and they can provide services to make your job easier. Managing a few single-family rental properties is much different than managing commercial properties, so you may want to leave this big task to the pros.

8. Assistance with making and managing investments

Having a real estate mentor who can guide you through making and managing your commercial investments will support you when you need to make tough decisions. You can use your property management company to assist you with your commercial real estate investments or you can build your own team. On this team, you’ll need a:

  • Commercial real estate agent with experience in commercial real estate.
  • Real estate attorney.
  • Property manager, especially on multifamily properties — an investor trying to be both manager and investor can get overwhelmed.
  • Reputable and licensed contractor.
  • Private individuals or financial institutions that can loan money immediately outside the initial investment if unforeseen circumstances arise.
  • Insurance agent.

Many property management companies that manage many properties will already have a team with these individuals on board, which is why they can be so helpful to commercial real estate investors. If you want to create your own team, these are the people you should surround yourself with to build your commercial real estate legacy.

Know the Basics of Commercial Real Estate Investing

Even if you’re an experienced residential real estate investor, commercial property investment can feel like a whole new world. And there’s definitely a whole new language. Here are the basic terms you should learn if you want to master commercial real estate fundamentals:

  • CAP rate: CAP rates can help you determine the risk of a property, and are significant when it comes to multifamily properties. Understanding cap rate can be complicated — but don’t worry! BiggerPockets’ detailed Cap Rate Guide will walk you through everything you need to know.
  • Cash on cash (COC): The cash-on-cash return on a real estate investment is key to knowing how profitable the property will be over the lifetime of the investment. It can tell you whether you’re getting a good deal on the property.
  • Net operating income (NOI): To accurately estimate the net operating income of a property, you’ll need to factor in all costs of operating a property with all income related to the property. By subtracting the income from the expenses, you’ll get the NOI.
  • Absolute NNN (Triple Net): These are common for retail, industrial, and office properties. Also called NNN leases, these absolve the property owner from paying most building expenses. The commercial tenant will cover real estate taxes, property insurance, and maintenance costs.
  • NN (Double Net): Under a double net lease, the commercial tenant pays the base rent specified in the lease, as well as their share of the property taxes and insurance premiums.
  • Real estate investment trusts (REITs): A REIT pools cash from many different investors and receives dividends from the building’s income. If the REIT is publicly traded, shares can be purchased via a brokerage. Otherwise, you can buy a share directly from the REIT.

Barriers to Investing in Commercial Real Estate

Investing in commercial real estate has a lot of benefits, but there are going to be barriers to overcome. You’ll need to learn everything you can before you take this type of investing on. These are some of the most common barriers to investing in commercial real estate:

  • Not understanding CRE financing: Investors who show significant losses or don’t show sustainable profitability and financial stability over the long term may have their initial mortgage applications rejected by the lender. An impressive balance sheet can be the difference between obtaining a commercial property or losing the bid. Close attention should be paid to sustaining and maintaining a strong balance sheet and any negative influences should be remedied.
  • A lack of experience investing in CRE real estate: Any commercial real estate investor should have some prior commercial real estate investing experience. If there is absolutely none, it is a good idea to partner with someone who has experience in the same asset class that you are trying to purchase. They can also help you better understand the commercial real estate market, which is a completely different beast than its residential sibling.
  • Not carrying out due diligence before buying a commercial property: Another significant barrier to entry when considering commercial real estate investing is not performing enough due diligence. Due diligence includes looking into the financial background of the property, the demographics of the property — its location and tenancy figures — the property class that it falls under, and how many times it has been resold in prior years. Properties that are resold countless times may potentially be a bad investment, and investors should proceed cautiously with them.
  • Poor underwriting: Another barrier that may be overlooked is proper underwriting. A good underwriter determines the accuracy of the appraisal and ensures no one else is on the title and that the financing fits the loan. Not performing detailed underwriting or skipping this step altogether can make a potential sale or even a final sale a real nightmare for all parties involved. 
  • Not having a team in place: This next barrier to entry is much overlooked and should not be. Have a team in place. Commercial real estate investing is a venture, plain and simple. Not having others involved who can assist an investor, especially a novice one, can only lead to headaches.

The bottom line

Commercial real estate investing is a great choice for many reasons. This is not to say there are no risks involved, however. Investing in any type of real estate, especially in higher-priced commercial real estate (such as MFH), may be risky. The market goes up and down, the area demographics can go up and down, and the overall price of resale can go sharply up or down.

Add to that any changes made to the property, as improving a property can initially add additional rental income. However, occupancy drops during renovations — and hence income generated decreases, too. 

Of course, there are also a myriad of tax benefits for property owners. Self-employment tax deductions may be available. A good real estate-certified public accountant (CPA) can assist with determining which tax benefits apply in each individual case. The government can truly be a commercial real estate investor’s best friend.

Overall, being highly proficient in commercial real estate fundamentals can help you diversify your portfolio. Doing the research and following the guidelines to overcome commercial property investment barriers will help both novice and experienced investors immensely.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.