Investing in commercial real estate is a fascinating and rewarding experience if you have the right information. I recently shared some successful investing tips on an episode of the Commercial Real Estate Show.
Market Cycles & Timing
Economic cycles profoundly affect commercial real estate markets. The commercial real estate market follows the same cyclical pattern:
The only question is how long each phase will last and how high and low prices will vary. Buying in the Recovery phase or early in the Expansion phase is the best timing historically.
The current Expansion cycle is ‘long in the tooth’ – but there are good reasons for that. The severity of the last Recession phase and the slow economic recovery has limited new construction in a way that has had positive results for commercial real estate performance. Occupancy and rents are steadily increasing in most market areas. Many believe the slow growth of the economy will result in a longer expansion phase than we have seen in the past.
A couple of recent articles suggest we’re approaching the top of the market. Take that with caution. It’s true – for gateway markets like NYC and San Francisco, class A stable properties are trading at cap rates as low as 3.0%. Some pundits tend to speak broadly about the U.S. market, which can be misleading.
If you look at specific property classes, markets and submarkets you’ll find that most of the country is still in Expansion mode and some spots are still in Recovery. The U.S. is huge and varied, composed of many secondary and tertiary markets, as well as B and C class properties. This diversity provides plenty of profit potential opportunities for buyers and sellers around the country.
Time to Sell?
If you own stable leased income properties in major markets, it could be time to sell, and selling in the Expansion phase can be a smart move. Especially if you feel interest rates will be increasing, which they will. Trying to time the absolute top can be fool’s gold. Plenty of people remember offers they turned down in the last expansion phase, they later wished they had accepted.
An Investment for Every Wallet
Not only are there a great variety of markets to invest in, there are also many methods to invest in commercial real estate. There is literally something for everybody:
- Institutional quality class-A properties in gateway or secondary cities
- B- & C-class properties in secondary and tertiary markets
- Duplex and four unit apartment buildings
- $5,000 in a property through online Crowd Funding
- Shares in a REIT
Real estate has several benefits over other investments. First consider the power of positive leverage – the spread between the mortgage rate and the cap rate. Additionally inflation increases rents and property value over time. Another powerful advantage is principal reduction. Your tenants are paying down the mortgage on your tangible asset.
Ready to Get In? What should an investor look for?
First it’s important to understand your goals:
- Which is more important to you: safety and stability or higher returns?
- How much capital do you want to invest?
- How long do you plan to own the property or stay in the investment?
- Who and how will the property be managed?
- Understand available financing, LTV, rates, costs, requirements and time to close.
Then consider some best practices:
- An under-performing property could be a gem in the rough, especially if that’s due to poor marketing or management. Create value with better leasing and smarter management. The key is to buy at a cap rate that makes sense, if you can, based on existing income.
- Choose market areas that show promise for job and population growth
- Work with a skilled commercial agent specializing in the property sector of interest for identifying properties with potential.
- Educate yourself on the market, browse the Commercial Real Estate Show audio, video and articles. Dig deeper into the individual sectors. You’ll hear about best practices, trends and market projections.
Property Types: Sectors, Classes, & Sizes
Single-family homes and condos are often where people begin in real estate. It’s wise to own your own home to live in, but as an investment there can be challenges. When a tenant leaves you have carrying costs, possible extensive turnkey costs, potential security issues and you have 100% income loss. Typically investors buy single family rental homes don’t consider the costs of management, turnkey, replacement reserves and vacancy.
Small apartment buildings buildings are the next step up. If one unit vacates the other tenants keep on paying. Refreshing a unit is less expensive than with a house.
B and Capartment complexes, either investing directly or with a general partner is another way to step up to something larger. All indicators show demand is strong for rental housing; just know your market.
Industrial property, while core institutional assets are hot, but there are many other classes and sizes of industrial properties right in your own back yard. Consider access, utilities, ceiling height and other potential functional obsolescence factors.
Office market is experiencing strong growth now. Both the lack of new construction and job growth in a growing economy are driving opportunity. If you own or lead a company, your business can be your own best tenant.
When I started Bull Realty, I bought an office building and occupied part of it. As we grew we relocated tenants and eventually took over the entire building. When we outgrew the space, it became a nice rental property to hold for investment.
Lenders love owner occupants. Take a good look at your options; make sure the space and location is right for your business. If so, it might be great investment property.
Retail is the last sector to improve after the Recession, and some areas are still struggling to achieve full recovery. Therefore retail can offer some excellent upside. The retail world is experiencing major flux now – creativity can be profitable.
Self-storage can be a good opportunity. It’s one way to hold land for future development while reaping income. It’s also straight forward to manage.
Medical office is a rising sector meeting a growing need. Medical office buildings provide slightly higher cap rates than regular office. The tenants can be long term and stable. It has its own quirks, so chose an experienced broker.
Read more: CRE Investment Guide Part 2
Michael Bull, CCIM, is the host of the Commercial Real Estate Show, heard by millions of people around the country on 42 radio stations, iTunes, YouTube and the show web site CREshow.com. Michael is an active commercial real estate broker with Bull Realty, a U.S. commercial real estate sales, leasing and advisory firm headquartered in Atlanta. Michael on Twitter, LinkedIn or 404-876-1640 x 101.