Is commercial real estate (CRE) a good investment for entrepreneurs? There’s no one-size-fits-all answer. While CRE can provide investors with better returns than residential properties (an average of six percent to 12 percent annually versus one percent to four percent in residential properties), they also require more of an initial cash outlay.
Entrepreneurs need to know the facts about commercial real estate before deciding whether it’s a good investment for them. Here are five things to consider.
What Are Your Goals?
This one is key to every financial decision, and it’s no less true of CRE. Are your goals to buy and hold for annual return? To buy and sell in a few years to realize profit? For each, how much return or profit are you seeking? Are you looking at CRE to enhance your tax picture? Do you want to own a single property? Redevelop a property for more future income? Own a portfolio of properties?
A disciplined plan needs this bedrock analysis of your own investment goals.
What Is the Outlook for the CRE Market?
The robustness of CRE real estate markets, like residential real estate, varies greatly by region and city in the US. Some places, such as Las Vegas, have suffered downturns both in rents and in vacancies. Others, such as the San Francisco Bay Area, have high rents and few vacancies. The fortunes of commercial real estate often reflect those of the overall economy in the area. Do research to determine the current and past economic performance, as well as the forecast for the future.
What Are Your Investment Parameters?
While CRE might offer a higher annual return, it also requires a higher annual investment. Robust real estate markets might offer low vacancy rates, but they are also more likely to be higher-priced. Assess how much of an investment you are prepared to make. How much of a return are you aiming for?
The answers to these questions will tell you the number of buildings, type and market that suit your investment profile.
What Type of CRE Do You Want to Invest In?
CRE covers a wide range of property types. Office parks, warehouses, industrial buildings and malls are all CRE properties. So are large apartment buildings and mixed-use buildings that combine, say, offices with a residential tenant. Each of these types have a profile for the amount of involvement required of an investor and the investment picture. There are also CRE Real Estate Investment Trusts (REITs), which allow investors to purchase a portfolio of properties managed by asset managers. In this case, investors are not themselves managers of the CRE and do not directly engage with the physical property.
What Are the Financial Parameters of Potential Properties?
There is no substitute for a detailed financial analysis of the properties you are thinking about. At a minimum, you should know net income (income less expenses), expected return on investment (the cash flow less any investment costs), the cash flow (net income minus any debt financing payments), the capitalization rate, the total return on investment (cash flow, accrual of equity, appreciation of the property and taxes), and the cash-on-cash return.