Real EstateCommercial Real Estate Investment Basics

Commercial Real Estate Investment Basics

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Commercial real estate (CRE) is a broad subset of real estate that comprises any property used for commercial purposes, including hospitals, retail stores,  office buildings, storage facilities, amongst others. Commercial real estate is a more stable investment option than the other real estate sector due to its longer lease lengths. 

Are you thinking of the best way to invest in commercial real estate in California? There’s nothing to worry about, seeing as there are many opportunities for the real estate agent, renter, and investor under the commercial real estate sector. 

However, before jumping into any investment opportunity, you’ll need first to understand the commercial real estate basics to avoid any mistakes. 

In this article, we will discuss the benefits of commercial real estate investing, CRE investing trends in 2021 and 2022, various commercial real estate loans and passive investing as a CRE investor, and tax benefits of commercial real estate. Let’s dig right in!

Benefits of Commercial Real Estate Investing

Commercial real estate investing is a personally and financially rewarding venture. For many investors, the reason for preferring commercial real estate is to gain security and future wealth, while for others, it’s for investment portfolio diversification and tax benefits. 

Regardless of your reason for choosing commercial real estate investment, the following are some of the benefits you’ll enjoy:

  • Higher Income

One significant benefit of commercial real estate investing is the higher potential income you enjoy. Compared to single-family properties’ one to four percent return on investment (ROI), commercial real estate has better ROI, between six to 12 percent.

Furthermore, CRE reduces vacancy risk due to the many available units in most commercial real estate properties. Lastly, commercial leases are often longer, meaning commercial property owners don’t usually experience low tenant turnover.

  • Cash Flow

Due to commercial properties’ longer lease periods, investors enjoy a consistent income stream. Not to mention that commercial real estate properties have more units than residential properties, meaning you can multiply your income streams quickly and achieve economies of scale. 

As a commercial real estate investor in California, you can opt for a triple net or NNN lease where your tenants pay for the building’s taxes, maintenance cost, and property insurance, increasing your landlord benefits. Suppose you’re interested in this option, you can find NNN properties here in California by checking out NNN Deal Finder.

  • Less Competition

Due to the perceived difficulty commercial real estate investment poses, most beginner investors tend to shy away from it. Thus, there’s less competition, and the sector is relatively unsaturated. 

Commercial Real Estate Investment Trends In 2021 & 2022

Due to the CoronaVirus pandemic in 2020, 2021 didn’t start well for commercial real estate investors. However, experts predicted that the sector would stabilize before the year ran out. 

While commercial real estate investors aimed to reduce costs by 25 percent in 2021, the sector witnessed many surprises, including increased demand for industrial CRE properties. 

The following are some predicted commercial real estate trends for 2022. However, it depends on your preferred CRE investment type and their performance predictions. 

  • Offices

Demand for offices is expected to reduce by 15 percent in 2022 as more companies adopt work-from-home policies. Therefore, office building supply will outweigh the demand. 

Since 2020, we’ve witnessed the hybrid office policy’s emergence, requiring workers to only come in the office on specific days of the week. This continuing trend might destabilize office spaces while companies find ways to sustain some in-person workdays.

  • Apartments

While we initially expected multifamily properties to struggle due to many renters’ inability to pay rent during the pandemic, surprisingly, apartments performed well. The housing demand hasn’t reduced, and apartments are at feasible prices with historically low-interest rates, and we can predict that they’ll remain stable all through 2022. 

  • Retail Stores

Several department and retail stores became bankrupt in 2020 and continued in 2021 due to the high COVID-19 transmission rates and quarantine effects. As people continue to shop online, commercial real estate experts predict that there will be 25 percent fewer retail stores by 2025. 

Alternative stores like grocery and healthcare are likely to replace some retail stores in urban cities like San Francisco, California. 

  • Hotels

Amongst the mentioned commercial real estate sectors, hotels are predicted to be the most badly hit, with some not expected to recover and run optimally again until 2023. Despite the eased regulation on traveling, upscale hotels offering amenities to travelers might not be able to stabilize until 2025. 

As people try to stay away from densely populated places, hotels in these highly populated cities might take longer to recover. 

  • Warehouses

Warehouses are the only sector expected to perform favorably amongst other CRE investments. Companies will want to keep up with the increasing demand for products from Internet users, leading to the success of this sector. Experts predicted a 250 million square feet demand for warehouse spaces in 2021.

Types of Commercial Real Estate Loans

  1. SBA 504 Loans

The 504 loan offers fixed-rate financing for significant fixed assets like land or existing buildings. However, unlike the SBA 7(a) loan, private lenders don’t fully fund 504 loans.

Nonprofit corporations under the Certified Development Companies (CDCs) make these loans available to promote economic development in their neighborhoods. However, the CDC finances about 40 percent of the project while a private lender will fund 50 percent. The CDC coordinates and structures the financing plan. 

  1. SBA 7(a) Loans

This SBA loan is more common than the 504 loan and is perfect for buying real estate properties due to its flexibility. Once you meet the loan requirements and include vital information like where you operate, credit history, and business income, you’re on your way to securing the loan.

  1. Hard Money Loans

These loans are issued by individuals and private companies and don’t require much repayment proof. On the other hand, they focus on the property’s value and sell the building when you default on your loan. 

While the approval process is easy, the interests are pretty high, and the loan duration is short, with the maximum being five years. 

  1. Bridge Loans

While bridge loans are similar to hard money loans, they’re different because financial institutions offer them rather than personal individuals. However, bridge loans are short-term options, with a maximum of one-year duration and high-interest rates.

Most investors use bridge loans to get funds for sustaining their cash flow while improving the property. Some also use it for commercial property leasing and refinancing, especially while waiting for long-term financing.

  1. Permanent Loans

A permanent loan describes a commercial real estate property’s first mortgage. They’re that variable-rate or fixed-rate loans most commercial lenders offer, resembling consumer mortgages. However, they have an extended amortization schedule than most business loans and are easily adjustable to fit your special needs.

Passive Commercial Real Estate Investments

To become a CRE investor, you don’t have to be active in managing your investment property. The following are some of the ways to earn passively through commercial real estate:

  • Real Estate Syndication

A commercial real estate syndication involves pooling funds from various investors to buy a commercial property. The syndication can be many investors purchasing a shopping center or a few investors acquiring a small office building.

The syndicator can use the raised capital for the project’s acquisition, construction, renovation, development, or tenant improvement. At the end of the project, the syndicator and investors share the profit. 

  • Real Estate Mutual Funds

Mutual funds are a low-cost alternative to most passive real estate investment choices. Similar to exchange-traded funds, mutual funds offer future returns that will help you attain financial freedom.

  • Exchange-Traded Funds

An exchange-traded fund or ETF entails grouping bonds or stocks into a single fund. However, ETFs come with lower costs and similar diversification like mutual and index funds.

ETFs investors can invest in stocks through real estate investment trusts (REITs). These stocks might include hospitality, retail spaces, and office buildings.

  • Real Estate Investment Trusts (REITs)

You can diversify your portfolio by investing in multiple asset classes through real estate investment trusts. However,  go for publicly-traded REITs and stay away from non-traded REITs. 

Presently, non-traded REITs have become infamous for their higher fees, high risk, lack of transparency, and absence of liquidity. 

Take the First Steps to Invest In Commercial Real Estate

If you’ve read up to this point, you’ve probably learned the best way to invest in commercial real estate and decided CRE is an investment option you want to pursue. However, consider starting by finding a financial lender who will explain the loan options available to you according to your investment’s specific needs.

You’ll also speak to an experienced commercial real estate agent to know what to expect from the venture you’re planning to undertake. With the proper financial backing and the right project, you’re on your way to generating wealth and earning passive income sooner than you think.

Commercial Real Estate and Taxes

Suppose you’ve been asking “how much tax do you pay when you sell your house“, commercial real estate investors enjoy certain tax benefits with or without selling their properties. These benefits include but aren’t limited to:

  1. 1031 Tax-deferred Exchange

The 1031 exchange enables CRE investors to defer paying capital gains taxes once they exchange their sold property for a “like-kind” commercial property under a specified period. 

However, the like-kind property will be equal to or greater than the initial property. Another exception is that the first property shouldn’t be a primary residence (single-family home).

  1. Income Taxes Depreciation Deductions

Like other physical assets, commercial properties wear down with time, and investors can deduct a particular amount from their income taxes every year to handle this depreciation. Presently, the Internal Revenue Service (IRS) allows a 39-year commercial buildings depreciation for property owners.

  1. Interest Expense Tax Deductions

As a commercial real estate investor, you can deduct your commercial mortgage interest from your federal income taxes. Construction loans and similar high-interest financing borrowers will find this tax benefit quite helpful. 

Final Words

And it’s a wrap! Hopefully, you’ve learned the best way to invest in commercial real estate. Note that commercial real estate properties are usually more expensive than residential buildings. However, you can bank on its stability and passive income earning potential. 

Regardless of the CRE sector, you wish to begin your investment journey with, ensure you work with a reliable commercial real estate agent and speak to a lender for available loan options according to your investment needs. 

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