Investing in commercial real estate can be a great option for investors who want to strategically build wealth for retirement. The average return for commercial real estate is 9.5%, making it a strong income generator in the asset arena. For those who are already familiar with investing in residential real estate, you will notice there is some overlap between the investment types. Commercial properties include apartment complexes, high-rise condos and multi-family dwellings with more than four units.
This guide will go over the benefits of investing in commercial real estate, the types of commercial real estate you can invest in, and how you can get started.
What is Commercial Real Estate Investing?
A property that is usually leased out for business or retail purposes falls under commercial real estate. Investing in commercial real estate means that you plan to purchase or help develop properties intended to house commercial tenants. Rent is collected from whichever business or organization occupies the property.
Investing in commercial real estate can include buying undeveloped land with the intent to use it for commercial purposes. Let’s see how commercial real estate investing compares to residential real estate investing.
Commercial vs. Residential Real Estate Investing
Although there are some similarities between investing in residential and commercial real estate, there are some key differences investors will want to keep in mind. Commercial real estate is a catch-all phrase that refers to significant market segments like retail, office, and industrial properties.
Essentially, commercial real estate refers to any property that can be used explicitly for business purposes. Residential real estate, on the other hand, refers to any property that is built specifically for a residential rental property. So how do the investment types differ? Is it better to invest in commercial real estate or residential real estate?
The primary distinction between these property investment types is found in how they are rented or leased. First, unlike residential real estate where investors collect rent from tenants who live there, commercial real estate investors rent out their properties and get their rent from the businesses that occupy them. Commercial leases typically have longer rental terms than residential properties which reduce the cyclical opportunities for vacancies.
Having vacancies means your asset is not earning income which may have an impact on your retirement goals. Residential properties have lease terms that commonly range from 6-12 months whereas commercial properties can range from 3-10 years! Commercial real estate investing can also be conducted through a property investment funds that allow for fractional ownership.
Finally, it may be easier to begin investing in residential properties due to their costs being lower, as an example. Investing in commercial properties may have additional hurdles to overcome like zoning requirements for different types of businesses and initially higher costs for the properties.
As you can see, while the underlying principles remain the same, there are some fundamental aspects of the investing process that differ between residential and commercial real estate. That’s why having an investment strategy with a well-defined plan, calculated potential investment costs, and having an idea of expected return on investment is important to help you reach your retirement goals.
Benefits Of Commercial Real Estate Investing
There are several benefits to investing in commercial real estate. Many residential real estate investors are taking the plunge into commercial real estate by purchasing larger multifamily properties.
For starters, leases in commercial real estate tend to have more concrete terms in place for tenants. With more reliable leasing terms, tenants are more likely to be attracted to the stability they provide. This can lead to steadier income for investors.
Furthermore, investing in commercial real estate isn’t necessarily something you have to do alone. You can join a property investment firm that will do the heavy lifting for you concerning legalities. You can also join a real estate investment trust (REIT) that allows for fractional ownership. These pooled resources are a great added benefit to commercial real estate investing.
There are different types of REITs. You just have to do your research and see what is best for you.
To truly reap the benefits of your commercial real estate investment, think about your long-term goals. Patience can be well-rewarded as higher (average) returns generated from your commercial property investment can lead to sizable growth in your retirement account.
How to Get Into Commercial Real Estate Investing
Like any investment type, the first thing you’ll want to do is your research. Doing your due diligence is critical to your success in commercial real estate investing. First and foremost, be aware of the risks and rewards that come with investing in commercial real estate.
Remember, commercial properties can have higher price tags than residential properties. It is also important to have a plan for potential vacancies, future renovations, or any other expenses.
You will also need to research the type of commercial real estate you want to invest in, but also your optimal market entry point. This is about timing as much as it is about location and your tenant type. These two factors may help you assess your investment to ensure fewer vacancies
The next step is to assess comparable properties in the area where you wish to invest. This is similar to residential real estate investors who compare the similarities between the location, size, and style of recently sold properties.
This research will enable you to figure out the present value of a property. If you have any questions about specific properties or the market analysis process, for example, we recommend speaking with a commercial real estate professional.
For commercial real estate (unlike residential) you will have to stay on top of certain costs like operating income, cap rates, and cash on cash. A real estate calculator is a great resource to determine these metrics too.
Types of Commercial Real Estate
There are five main types of commercial real estate. Investors will want to consider each one based on the best use of leverage depending on their unique financial situation. As Warren Buffet said: “Never invest in a business you cannot understand.” Choosing a commercial real estate option that will be advantageous to you’re retirement plan will depend on what makes the most sense for the future of your financial freedom.
We are going to take a look at some advantages and disadvantages of various types of commercial properties to help you determine which area of specialization may be a good fit for you.
Office space is the most commonly known commercial real estate class. Ranging from single-tenant offices to skyscrapers, these properties can all be grouped into one of three categories: Class A, Class B, and Class C.
Class A Property
Class A properties tend to be extremely desirable, investment-grade properties with the highest quality construction and workmanship, materials, and systems. They can typically be found in desirable locations that have convenient access to important amenities. Professional real estate management companies are usually implemented to ensure first-rate maintenance and management.
Class A properties are considered the safest real estate investments with the most reliable income. These property types carry a lower risk threshold. In return for greater safety and stability in this investment type, returns tend to be lower.
Class B Property
Class B properties are still in good condition, but not excellent. They won’t have all of the bells and whistles like the brand-new infrastructure being built. The building’s systems will be in adequate condition and the property will be structurally sound, but maybe not overwhelmingly impressive.
These spaces tend to have more utilitarian purposes. Older properties tend to fall into this category as newer infrastructure goes up around them.
Class B properties can be great opportunities for someone to obtain commercial real estate at lower costs. They are riskier and more speculative investment types compared to class A commercial office properties. On the upside, capital funding entry point requirements might be lower, which can be more opportune in the arena of commercial real estate investing.
Class C Property
Class C properties present investors with an opportunity for potentially higher returns through redevelopment. It carries a much higher risk threshold as these property types require major capital investments for renovations and are typically poorly located with higher vacancy rates.
Class C investment types may be great opportunities to flip. It is worth noting that a thoughtfully updated class C building that meets the criteria can be reclaimed as a Class B or potentially Class A building.
Retail real estate is present in some form or another in most of our daily lives. Restaurants, malls, shopping centers, healthcare facilities, banks, warehouses, and other shopping outlets are all commonly used retail spaces. Some retail properties may even require a lower deposit amount compared to other types of commercial or residential real estate.
It is common for retail leases to have the tenant pay the property taxes. Depending on the lease agreement, the tenant may also be responsible for other expenses as well.
Industrial Real Estate Property
Industrial spaces are primarily used for manufacturing purposes— think large warehouses to industrial manufacturing sites. These buildings are typically designed with height specifications to accommodate manufacturing needs and docking availability.
Multi-Family Real Estate Property
Any property that has more than one unit can qualify as multi-family real estate. If it has more than 4 units, it can also be considered a commercial property. Apartment complexes, high-rise condominium units, and smaller multi-family units all fall under multi-family properties.
This type of investment is a prime example of how residential investors can segue into commercial real estate. Residential real estate investors are often taking their first steps into the commercial real estate business investing in bigger multifamily properties.
Special Purpose Real Estate Property
As the name indicates, special-purpose retail property is intended for a specific purpose. It has limited utility and marketability and is designed in such a way that it would be difficult to repurpose the property for another use.
Car washes, hazardous waste facilities, oil refineries, and self-storage facilities are all examples of special-purpose properties. Alternatively, leisure and tourism facilities, like hotels, airports, sports stadiums, and amusement parks may also fall into this category.
Lastly, mixed-use development properties that can serve different uses are continuously growing and increasingly in demand. Think about live-work-play properties that rent out retail and commercial services on the lower floors with residential spaces on the upper floors.
Using IRAs to Invest in Commercial Real Estate
Many people are already familiar with Roth and Traditional IRAs. Did you know using a self-directed IRA allows you to directly find, pick, buy, and sell real estate with your retirement savings? Using your IRA to invest in real estate is a great way to get in the game.
For instance, a non-recourse loan obtained by an IRA offers investors who don’t have a sufficient outlay of capital the opportunity to secure a loan through collateral (usually the property being purchased).
This option also provides investors with some insulation in the event of a default or foreclosure. Lenders are only limited to seizing the asset used to obtain the financing, but cannot take legal action or pursue the IRA owner’s other assets. That’s just one of the perks of investing in real estate through your IRA.
You can also leverage other people's money by partnering. There are many strategies that you can combine and use your IRA to invest in commercial properties. The key is to understand these strategies and hire the right custodian.
Let IRAR Help
IRAR Trust Company is glad to offer our community of investors a trove of investment resources. We offer free guides that will walk you through the process of how you plan for a retirement of financial freedom through alternative assets at a lower cost. Check out our guides on other types of IRA real estate investments and strategies, such as how you can purchase an investment property through your IRA.
Last, while reading about the ins and outs of real estate investing through your IRA is an essential part of your due diligence before deciding what you want to add to your portfolio, nothing beats a little human touch. For more than 25 years, IRAR Trust Company has empowered investors to achieve their retirement goals.
Give us a call at 888-322-6534 or schedule a free consultation today to find out more about how IRAR can help you get the most out of your IRA retirement planning.