Commercial property is a general term that entails a real property which an investor utilizes to generate profit. Some of the commercial real estates can be hotels, malls, farmlands, warehouses, apartment buildings, industrial property and office buildings.
There are two crucial aspects that any investor that is interested in the commercial real estate ought to grasp:
- In a commercial real estate there exist two way one can generate revenue, that is, appreciation and income. Appreciation usually results when a particular property increase as time passes by resulting in some gain. Income can be harvested from the operations taking place in the building.
- When it comes to the diversification of the commercial real estate portfolio, investors should be cautious. A lot of time, capital and expertise input will be needed in large measure for such investments.
General analysis of commercial investments
Easier portfolio diversification and attractive risk-adjusted returns found in the commercial real estate attracts millions of investors to invest in this alternative asset. However, how this investment vehicle works still challenges many investors.
Commercial real estate investment is quite different compared to traditional investments like bonds and stocks. While the secondary market is where frequent trading of bonds and stocks take place, trading of a real estate is mostly in the primary market as it is the hard asset that has intrinsic value and is normally a scarce resource. Rather than their income potential, stocks are mostly traded due to their capital selling potential.
Aspects of commercial investment working
When it comes to commercial real estate analysis, the investment strategy is usually simple and not complex as many would think. The investor will have to look at the real estate inherent demand prevalent in a particular area.
Remember, we highlighted that after purchasing a property, investors could make money using it through two ways: you can lease the property for use and charge tenants rent or could let the property continue to appreciate value as time goes by so that you can later sell it in future. As such, let us keenly focus on these two investment opportunities aspects.
Rental income purpose
Across all commercial property types, tenants tend to differ. As such, lease agreements, property management needs and arrangements are all different due to the different tenants available.
Office: tenant may occupy the parking and cubicle decks in a particular building. The tenants, for instance, a start-up company or a law firm will have to pay rent based on the lease term, whether 5 or 10-year period.
Apartment Building: tenants who are families or individuals are the ones who usually occupy these multi-family apartment buildings. Tenants and leases in this kind of buildings can be plenty to manage since the monthly payments can huge to handle.
Industrial: some of the common industrial establishments include smokestacks and warehouses which house distribution or manufacturing companies as typical tenants. These properties include a lease lengths that can take 5 to more years. Such establishments are usually set up in areas where a retail or residential property would be undesirable to be set.
Value addition and appreciation
The increase of a property’s value that an investor holds for a certain period is another viable opportunity that can accrue returns from a commercial property investment. However, even for the most disciplined investments, properties still run the risk of losing value even if the most proven strategies are employed due to other outside economic forces.
Since there is no way of creating more land, the real estate will remain a scarce and unique asset. More demand in major cities usually increases the scarcity. In that perspective, prospective buyers will want to pay more than originally in that area to get that property. Likewise, the tenants who want to occupy that premises will want to pay higher rent due to the increased demand and scarcity.
Appreciation due to demand is one way of gauging property value increases. The other way of increasing a property’s value or income earning ability is making some improvements to the property. It is such a value-addition approach in the commercial real estate that many investors now seem to take.
For instance, an owner of a multi-family apartment building could add the value of the property updating its appliances or cosmetic details. The owner will head to charge higher rent as the updates made will make apartments look nicer. Likewise, you could make external improvements to the property like rezoning the land parcel that is adjacent from being residential to be a multifamily that is capable of accommodating setting up of more buildings. In all cases, investment of renovating a particular building will usually escalate the property’s price in the future.
To illustrate how a real commercial investment works, let us assume an investor known as barley decides to buy 60 unit apartment building that is worth $8 million. He later decides to rent the unit to tenants that enable him to earn a yearly 650,000 after accounting for all expenses. When some of the tenants decide to leave the units during the year, barley renovates those apartments and then charges the new tenants’ higher rates for the renovated units. Let’s assume that for five years, barley makes improvements that enable him to yearly increase the property’s rental income by $50000 so that in the final year the yearly income becomes $750,000.
After the five years, barley could decide to sell the apartment building for $16 million. A buyer is more willing to pay a higher price for the property. The renovations make buyers to pay more to purchase the building as the income gained has significantly increased. New tenants and businesses in the neighborhood have spur economic growth in the area.
What can be deduced from a commercial real estate investment?
According to the available statistics, the not everyday investor has the necessary the huge resources invested in the commercial real estate directly. The commercial property investment seems to be the territory of institutional investors who have deep information reservoir of operating a commercial property and a lot of capital amounting to millions of dollars to finance the projects. Fortunately, any investor can plunge into the private commercial real estate market through a diversified portfolio that usually offers high returns, has a low minimum and low fees.
The bottom line in commercial real estate investment
- A commercial real estate usually a hard asset that is scarce and has an intrinsic value that seems to appreciate as time goes.
- The larger economic growth also determines a commercial real estate’s value.
- As opposed to stocks, it is possible to gain a stable rental income cash flow from commercial real estate investments.