Learning how to invest in commercial real estate (CRE) may seem intimidating at first, but these six fundamental steps focus on the main aspects of investing in CRE and show you that it's more straightforward than you may think.
These six steps are focused on active investing, where you as the investor are participating in the management and operation of the property. You may oversee the onsite manager or manage the property yourself, but ultimately you play an active roll in the success or failure of the investment.
There are other ways to invest in CRE that are more passive and do not require you to own or manage the properties yourself, like real estate investment trusts (REITs) or crowdfunding. It's up to you to determine the best method of investing in CRE based on your goals and preferences. However, if you're looking to actively own, manage, and invest in commercial property, here's how to get started.
1. Learn your niche
Commercial real estate encompasses a variety of property types that are analyzed, managed, and rented differently, and investing in CRE is very different than investing in residential real estate. For example, owning a storage facility is different than owning an apartment complex, mobile home park, or industrial building. Each property type has different expenses, types of leases, and sources of rental income. You need to understand how a triple net lease differs from a gross lease and how to factor in vacancy rates and determine the property's net operating income (NOI), among other terms.
Most investors specialize in one CRE type, learning the ins and outs of that niche including how to properly analyze, value, and manage the investment. Before you even begin to research investment opportunities, you need to conduct thorough due diligence on the process of investing in your area of focus in CRE and become competent in that form of investing.
2. Identify your market
Once you've determined what property type you are targeting, identify your market. You can invest in your neighborhood, city, county, state, or beyond. The goal is to find a market with an opportunity for your CRE sector where supply has not yet met demand and demand remains high. Look at current and planned development in the area, vacancy rates, and overall market performance for your sector. Situs, National Association of Realtors (NAR), and CBRE, Inc are great places to locate this information, although an experienced broker can help you as well.
3. Find an investment opportunity
Next, begin searching for an investment opportunity. There are several online resources for finding investment properties for sale, LoopNet being the largest, and other options like Crexi. You can also work with a commercial broker who specializes in CRE investments or target sellers directly using direct mail marketing.
Conduct your own due diligence on the property, including the feasibility of the venture or other factors that could positively or negatively impact the property.
The broker or seller themselves should provide you with current income and expenses, but keep in mind that sellers are trying to get the highest possible price, and brokers may unknowingly inflate the pro forma projections, leaving out certain expenses you feel may be necessary or estimating a higher rental income than the market supports. It's up to you to verify that information and determine your own pro forma projection of the property.
Once you've identified a worthy investment, you'll submit a letter of intent to the seller, and if the terms are agreed upon, enter into a formal contract.
4. Acquire funding
Immediately after the contract has been executed, you will want to work on acquiring financing. There are several options for financing CRE including:
Loan approvals can be lengthy, depending on the type of loan you are using. For this reason, it's important to get the loan process started right away as it can take anywhere from a few weeks to 45+ days to close.
5. Manage the property
After the loan has been funded, the real work begins. You now own a commercial property that you are responsible for maintaining and managing. If the property needs improvements, you'll be responsible for coordinating the repairs with contractors while maintaining the day-to-day operations of the property.
Depending on the size of the facility, it may warrant a part-time or full-time on-site manager or third-party professional management company or be something you can handle yourself using a property management software system. Make sure you have systems in place prior to closing so you can smoothly transfer ownership and start making the necessary improvements or desired changes, if any, right away.
6. Disposition of the property
The final stage of investing in commercial real estate is the disposition stage, which is the selling or liquidation of the property. When you're ready to sell the property or move on to a new venture, you can:
- Sell the property in a traditional sale (with or without a commercial broker)
- Sell the property with owner financing
- 1031 exchange the property
Investors have different strategies for disposition based on why the property was purchased. For example, if the property was purchased for cash flow, it's likely the owner will hold the property for many years or until depreciation is fully captured before selling.
But if the property was purchased for appreciation or because value could be added by raising rents, improving the property, expanding, or a combination of these -- it's likely the owner will sell the property after the property is stabilized and operating according to market performance.
These six steps are the main components of actively investing in commercial real estate. This is made to be a general overview of the investing process, not a detailed write-up about each stage of investing in CRE. If you're interested in learning more, continue to do your own due diligence and start working your way through this list.