Commercial real estate (CRE) is an asset class with incredible potential for small or large investors.
It was once a mostly private sector where individuals and investment first bought, sold, and built assets. But it's accessible to almost any investor through real estate investment trusts (REITs) and, more recently, crowdfunding. CRE is often perceived as an investment class available only to wealthy, well connected investors, but that’s not necessarily the case.
This historically high-performing asset class is more attainable and affordable than ever. Today we’ll explore how to start investing in commercial real estate by discussing four options for getting started.
What is commercial real estate?
Commercial real estate is physical property used for business purposes. CRE can be owned by the business that operates out of it or owned by a third party and rented through a lease. Here are some of the many types of commercial properties:
- Office space
- Hotel and lodging
- Self-storage or mini-storage
- Multifamily (e.g., apartment complexes)
- Retail (e.g., strip malls, malls, or single retail spaces)
- Industrial (e.g., warehouses or manufacturing buildings)
- Health care (e.g., hospitals, clinics, doctor’s offices, and senior care facilities)
- Land (e.g., timberland or farmland)
- Special purpose (e.g., churches, bowling alleys, or daycares)
Most CRE investors choose a specific sector to focus on and own multiple assets of that class. Others invest in multiple sectors of CRE to diversify their portfolio. When you focus on a niche, you have the opportunity to become an expert in that field. You can also improve business operations by using the same systems, services, or managers across properties.
CRE isn't the only option for investing in real estate, but it's one of the best options because there's safety in numbers.
When you invest in residential real estate, you're typically secured by one property, lease, or tenant. If that tenant leaves or damages the property, or a large expense like a new roof comes up, your return and cash flow could be reduced dramatically. Depending on the specific property or asset class, CRE has the potential to mitigate that risk by having multiple tenants in that one building. For example, retail centers, multi-unit office buildings, or apartment complexes spread your cash flow over several leases and tenants. While industrial warehouses, hotels, or medical facilities, for example, tend to be single-tenant commercial buildings.
With the options available in today’s market, it’s never been easier to start investing in commercial real estate. It can be as simple as buying a share or as complex as finding, acquiring, and managing our own commercial property. If you'd like to get started in commercial real estate, here are some questions to think about:
- Do you want to be a passive or active CRE investor? If passive is your choice, do you want to invest in an individual REIT, ETF, crowdfunding opportunity, or partnership?
- Which investment vehicle makes sense for the time and funds you have available? Identify the CRE asset class that has the most opportunity in today's market and find a few areas where opportunity and demand are highest.
- Which companies and investment opportunities are in those areas? Do your homework on the investment opportunity, the market demand, competition, and viability of the company based on past performance.
- Details on real estate opportunities
- Reports on the viability and historic yields of different commercial property types by geographic region
- Macro-level looks at the economy and CRE
- A whole lot more
Now that you understand what CRE is, let's take a look at how you might get started investing in commercial real estate.
Real estate investment trusts (REITs)
One of the easiest ways to start investing in commercial real estate is through REITs. A real estate investment trust pools money from investors to buy several properties in a given CRE sector.
There are REITs for every sector -- you might choose to invest in healthcare properties, for example, or office space. Even farmland. There are also REITs that invest in multiple property types known as diversified REITs. Most REITs are publicly traded, though there are private or non-traded REITs as well. Private and non-traded REITs are less liquid investments than publicly traded ones and typically require you to lock up your money for several years.
If you invest in a private REIT, do your homework on the company, their current holdings, and their past performance. Non-traded REITs specify a minimum investment amount, which is typically a few thousand dollars and up to tens of thousands of dollars.
However, there are newer platforms creating what are known as eREITs. These are public, non-traded REITs where the minimum investment threshold is much lower and you don’t need to be an accredited investor to qualify. To invest in a publicly-traded REIT you would identify a company in a sector you like and buy shares in that REIT through a stock brokerage account.
While you can buy shares of a single REIT, you also have the option of investing in multiple REITs with a real estate exchange-traded fund (ETF). A REIT ETF is also publicly traded. The fund allocates the investor’s money into several different REITs in different CRE sectors. This reduces risk even further -- your investment is now shared across property types and REIT companies.
REITs are an appealing way to start investing in commercial real estate because they:
- have low upfront costs,
- need no active management,
- receive passive returns in the form of dividends, and
- reduce risk through diversification.
Splitting the investment over properties also improves the profitability of the REIT. Having assets across locations, properties, and property types makes it more robust.
A study was conducted by the National Council of Real Estate Fiduciaries (NCREIF) that showed REIT average returns from 1994–2008. All CRE sectors but one beat the average return of the S&P 500 and Treasury bonds in that time.
REITs are a great way to start investing in CRE if you have limited time to actively own and manage a real estate property, don't have millions of dollars to invest, or want to diversify your portfolio.
Crowdfunding is a new investment option that allows accredited investors entry into CRE. Crowdfunded deals often receive higher returns than a REIT or ETF would offer.
This is an excellent option for someone who has money to invest but lacks the desire or time to actively own and manage their own commercial property. Crowdfunding pairs investors who have money with a passive investment opportunity from a third party.
Each crowdfunding platform vets the sponsor and investment opportunity. If the opportunity is deemed a worthwhile investment, the platform hosts it and invites approved investors to participate.
Each investment opportunity and crowdfunding platform has different minimum investment requirements, which can range from a few thousand dollars to hundreds of thousands. There's less liquidity with this type of CRE investment, as most investments have a two- to five-year period. During that period, the investor cannot withdraw their funds from the investment without incurring large penalties.
Crowdfunding is a riskier investment than REITs because the investors' money isn’t diversified across multiple CRE sectors or assets. The success or failure of the investment is heavily influenced by the sponsors' management of the asset and has can be more largely affected by a change in the local or global market. There is always the risk that the overall return is less than originally anticipated or the investor does not see a full return of capital investment. Some believe the risk is outweighed by the reward and see crowdfunding investments as long-term opportunities for high returns.
There are dozens of different real estate crowdfunding platforms, so take the time to find the right company to work with and understand how they analyze their investments.
Buy and manage your own CRE investment
If you have the time and capital, the best bang for your buck will almost always be buying and managing your own CRE investment. This option isn't realistic for everyone -- just because someone has the money doesn't mean they will make a successful investment. Nor does everyone want to become a landlord.
However, becoming an active commercial real estate investor lets you take advantage of tax incentives, earn passive income, and enjoy appreciation and equity capture.
To become a successful commercial real estate investor, there is a substantial amount of knowledge needed on a multitude of subjects such as local building codes, management policies, or crafting legal documents to name a few. While experience in residential investing can give you a nice foundation, there are several other concepts you might need to brush up on, such as:
- Common CRE concepts and terms like cap rate, net operating income (NOI), debt service coverage ratio (DSCR), and lease structures.
- The supply and demand for the various CRE sectors in the specific markets you are targeting.
- Determining your funding structure.
Becoming an active CRE investor takes a lot of time, knowledge, and active management. This avenue of requires a lot of work, but the payoff can be well worth it.
Partner on an investment
One of the less common ways to start investing in commercial real estate is by partnering on a CRE investment. It’s a passive investment opportunity similar to crowdfunding in that it is a pooled investment, but the number of partners is lower and the returns (and risk) tend to be higher.
Equity partners are common in the CRE world, but you must build relationships with active real estate investors to find opportunities. It's extremely important to conduct your own due diligence on the investment and the investor. They're managing the LLC, property, and ultimately your money -- so you have to be sure about them.
Investing in CRE takes work
If you want to invest in CRE, remember that there's no perfect market or sector. Opportunities in CRE change throughout market cycles and area. Know the risks of your investment avenue, and remember, all investments take work -- even the most passive ones. CRE is an incredible market that has tremendous potential for income and growth. But you'll need to invest a lot of time and effort into it.