There exist different types of real estate investments. Some choose the residential ones, while others decide to go for commercial real estate (CRE), which is basically a property for business. Investments into commercial units continue to gain popularity in the modern world and, despite having both pros and cons, a lot of people are willing to choose commercial rather than residential real estate.
Commercial real estate has different categories with their own peculiarities and risks. As with any other investment, it is essential to do the homework and go deeper into the world of commercial real estate in order to get the trends, know the market and understand what CRE is and why there is so much talk about it and not so much competition when it comes to proceeding with further investments.
What is CRE?
Commercial real estate mainly deals with various businesses. The investor rents the space, either for a company’s office, a drug store, or the whole shopping center, and gets the money from leasing it. Commercial properties are said to be giving very stable and high returns, which is why they are so much valued. Another great thing about commercial buildings is that the purchased property gets appreciation in the value over time, which is one more reason to consider this type of investment.
Commercial Real Estate Categorization
Commercial real estate has several categories, and all the properties are related to one of the five. The properties which fall under each category often have different performance and target absolutely different tenants.
Office properties are rented by companies and organizations which need enough space to allocate their business offices with all the employees. Such buildings are normally located in the business area of the city with a good location and transportation.
Office buildings have three main classes – A, B, and C. The properties which fall under A class have the newest facilities, high-class amenities, and location advantages. Properties in this category have comfortable transportation access along with all the great food and entertainment places around. Properties under the B class are related to older buildings with not so good and modern amenities. Such properties are not super expensive and are often targeted by investors. The last category has all the properties under the C class. Those buildings are most often old and require a massive renovation and redevelopment.
Industrial properties are designed as places for storage. It can be various data centers, warehouses, and other similar types of buildings. They are popular among those who need a place to store either personal or business stuff and are mainly chosen according to dock options. The existing amenities and facilities in the property will play a huge role and must be considered by investors.
Various apartment buildings that contain four and more units for people to live in and are located either in the same building or complex are considered multi-family spaces. People who look for a place to rent will be looking for specific sports and leisure facilities inside. This category of commercial real estate has a drawback of a small leasing period. If, for instance, industrial places can be rented for several years, the multi-family ones will start from a month to not more than a year.
Retail properties are associated with those providing consumer goods and services. Big malls, shopping areas, single shops, and cafes are categorized as retail. The buildings are often located in the city center or an area with entertainment and leisure facilities.
Special Purpose Spaces
This category includes those buildings which are designed to be used for specific purposes only and can hardly be changed. Amusement parks, for instance, can only be used as amusement parks, and the place cannot be redeveloped in the future. Other places include bowling places, car washes, hotel lodging, schools, and airports.
According to the NCREIF Property Index (NPI) among the above-mentioned categories, the industrial category of commercial real estate gets the top position due to being most successful, while the retail sector is continually losing its positions. Based on stated measurements, CRE investors usually decide what to choose to get the highest return and avoid the loss. Nevertheless, each category has an investor. If multi-family is good for one, it might not work for another one. To get a more clear understanding of what is better, one needs to start analyzing the market to make the right decision.
Advantages and Disadvantages of CRE
Commercial real estate gives an amazing opportunity to receive consistent returns from the leasing. However, like any other real estate investment, it has both advantages and disadvantages.
Advantages of CRE investment
Real estate is generally associated with significant advantages and, consequently, is a desired investment field. As for the commercial real estate, let’s look at a few things which might be very appealing for future investors:
- Income. When it comes to investments, the potential amount of money is the first thing everyone is looking for. The opportunity to receive stable and high returns is the reason why so many people turn into commercial real estate.
- Property appreciation. When investors choose a commercial property, they consider the possibility of its growth potential, which comes with time. If they invested in the building in the massively developing area, it is no surprise that in a few years, the property might cost three times more than it does now. The rental price then will be increased, and the investor will be getting a higher amount of money.
- Lower competition. Due to being quite an expensive investment, there exist not so many commercial property investors out there on the market. It doesn’t mean that there is no competition. Real estate is always about competition and working on increasing potential. However, commercial properties are said to be getting less pressure in terms of the number of investors.
- Rental period. One of the biggest pluses of commercial real estate is that the period of property rental is much longer than in residential, for instance. The longer period means the stability of relationships and income. Investors don’t need to think about changing tenants and risks of losing money.
It seems like commercial properties are all about good things and amazing opportunities. Nevertheless, in the world of real estate, there always exists another side of the story.
Disadvantages of CRE investment
Like in any other industry, real estate is no exception when it comes to evident drawbacks.
- The price. It’s a well-known fact about commercial real estate that investors will need to give quite a sum in order to get the deal. This is the thing to keep in mind before deciding to go for commercial property as the budget needed is relatively high, and expenses will be massive.
- Further expenses. This is something an investor should always be ready for, as you never know when it will be the time for building renovations or redevelopment. Investors should always think ahead and keep enough funds in case of unforeseen circumstances.
- Unstable economy. The economic situation in the country is something one can never foresee. If the economy goes down, commercial real estate can face serious consequences and lose its demand. This is a huge disadvantage as the investor can immediately lose all the stable returns for an unspecified amount of time.
- Competition. Having said that, competition is relatively lower when it comes to commercial real estate. It does not mean the absence of it. The commercial properties will keep developing and growing causing more competition and more threat for existing ones. This is when the constant upgrade is required and much needed.
Real estate, commercial one, in particular, will always have both advantages and disadvantages. Due to this reason, it is good to know what you are dealing with and get a better understanding of the industry and how it works.
What to consider before investing in CRE?
Before starting the journey in the world of real estate, the investors should put all their efforts into analyzing, learning, and researching. As they say, forewarned is forearmed.
When starting to investigate the commercial real estate, it is good to cover a few essential things:
- Market area, supply, and demand
- Real estate market cycle
- Economy situation
- Permissions and costs
- Track records
The real estate market is absolutely different in various geographic areas due to existing supply and demand. It might happen that one type of property is doing great in one area, but is undersupplied in another one. It is good to know where the specific type of property will be needed and where there will be no chances due to a huge amount of competitors.
Any business requires forehand preparation and research. Real estate is no exception, and understanding how the market works, what are the trends, what is currently working better, and what is not, will allow investors to have a bigger picture of the current situation.
Digging into the market cycle, on the one hand, might seem a tough and incomprehensible task. On the other hand, this is one of the first things to get the hands into before making an investment. The understanding of how the commercial real estate market cycle functions can bring great opportunities to save money or even to earn twice more than anticipated.
The economic situation is always the worst enemy of any investor entering the world of real estate. The market might drastically drop in value if the economy is not at its best. In fact, it is essential to understand the current situation and what consequences the investors might face. While the prices may go down, the debts might increase.
The costs in commercial real estate are quite high and apart from the initial price to be paid at the beginning, the investors should be ready to pay for many additional things not included:
- Advisers, surveyors, solicitors work
- Authority charges
- Renovation / Redevelopment
- The service charge for lightning and heating services
- Mandatory deposit (generally around 35-30% of the value)
Additional costs might come before the deal, after or during making one. Investors might need to spend additional funds for any extra payments, which might occur. These might include renovation, raising rents, or any other significant change. The cash flow will not be stable at first, so it is good to have some extra funds to cover the needs.
Whenever an investor is planning to get acquainted with the real estate world, one of the first things to do is talk to those who have already been there and know the rules. People with existing stories and vivid examples of working with commercial properties will be of great help to the first comers. Not everyone will be ready to share the numbers, but the first-hand experience is better than the dry statistics.
And lastly, speaking of risks, they will always be there. Commercial real estate is no exception, and the unforeseen circumstances can appear at any time, during any period. Among the most common ones:
- Market ups and downs;
- Environmental regulations changes;
- Changes in the amount of taxes;
- Account standard changes;
Investors need to know how to respond to critical situations. Some of them will definitely be out of control of the person, while others will be manageable and will not impact the overall picture. Investors need to continually monitor the situation to be able to respond to the risks on time. Sometimes risk can be a great opportunity to make money if treated wisely.
Commercial real estate will always be the property in high demand. It gives great opportunities but asks to overcome massive risks. It allows stable returns but asks for a lot of money. The key to a successful investment is a thorough understanding of what one is dealing with. It will help to avoid difficulties and show how to look for potential. Studying and analyzing, knowing the current situation, and learning on other’s mistakes might save a lot of money and help make the right decision.
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