With average rental rates having reached their highest level in a decade, commercial real estate (CRE) is an appealing investment. Deciding whether, when and how to invest is a difficult decision, and not without risks, but don’t fret. Before you put the first dollar down, make sure you know the answers to the most important questions regarding CRE investing.How will I make money from my investment?
As you consider CRE investment, you’ll need to decide whether you’re more interested in a land-centric or tenant-centric approach. You may choose to buy a piece of property with the intent to re-sell in five to 10 years after the land appreciates. Alternately, you may be more interested in having a steady stream of income from securing high-quality, long-term tenants. This kind of tenant-centric “coupon clipping” approach may have a lower risk with a steady cash flow, but typically has a smaller return in the long run. Choose the strategy that best aligns with your short- and long-term goals.
How do I select low-risk tenants?
If you’re considering the income approach, selecting quality tenants is key — not only to ensure a revenue stream, but also to secure a loan for the purchase. The property value of your investment matters to you as the owner, but your lender’s interest is in your ability to repay the loan through rental income, and this needs to be established prior to closing. In other words, the strength of your pre-leased tenants can make or break your ability to secure funding.
Some examples of low-risk tenants:
ɕ Publicly traded retail tenants with a published credit rating
ɕ Well-established brands in office environments with long-term leases
ɕ Government agencies and municipalities
Will I need to hire a consultant?
To make a successful CRE investment, you may need both a banker and a broker. There are a variety of factors that differentiate a lucrative CRE investment from a disastrous one, and a good broker can help you identify a property’s potential pitfalls. These factors include everything from a strip mall’s visibility from the road to the parking lot capacity of an office building.
How long should my leases be?
Lease length can vary based on the nature of your tenant agreement. In looking at the term, remember that “lease options” are always in favor of the tenant, not the owner, because the tenant holds the option. If you construct a facility to suit a tenant’s specific needs, you should seek a lease of at least 10 years. If the building is less customized, like a retail storefront in an anchored shopping center, a five-year lease at market value may be reasonable.
Should I consider custom amenities to attract and keep tenants?
As landlord, regular maintenance is your responsibility by default, but you might also want to consider going above and beyond for some of your tenants. For instance, you may find yourself considering an investment in extra refrigeration to accommodate a tenant with an extensive wine bar. But if that tenant leaves and is replaced by a family-style sports restaurant that has no use for the new amenities, your investment leaves with them. If you decide to finance a tenant improvement, make sure your tenant is willing to pay higher rent for the term of the lease — or make a one-time payment — to cover the cost of the customized space.
How does a CRE investment differ from an investment in stock?
When you invest in CRE, you have more control over that investment. While it may also prove lucrative to include stock in your investment strategy, the market is more dependent on external forces. Managed conservatively, an investment in income-generating real estate with strong tenants may carry a lower risk and be less influenced by the emotions that can cause volatility in the stock market.
Once I purchase property, what market trends do I need to monitor?
Real estate does not operate in a bubble. To ensure that your property remains competitive, keep an eye on the local CRE industry, especially vacancy rates and market values. Even if your building boasts a low vacancy rate, a nearby facility with a high vacancy rate and lower rent might lure away your tenants.
While a successful CRE strategy may take more effort and maintenance than other investment options, you can enjoy significant benefits through every stage of the process. Just be sure to enter the market informed and prepared, and you will be poised for success.