They can be multifamily (typically having four or more attached dwellings), retail spaces or offices, industrial or warehouse properties, or even developable land.
Since commercial properties are larger scale, they allow you to build your portfolio more quickly than buying individual dwellings. And of course, any real estate investment has the unique advantage of allowing you to leverage, or mortgage, your investment.
There are several factors you must take into account when evaluating commercial property. From the numbers you use to assess the property.
to the tax benefits and capital improvements you could make. And lastly, the business plan for the asset — are you growing organically or hoping to invest passively?
If you’re planning to take the investing plunge into commercial real estate, you’ll need to find the right inspection and financial report for your deal, and determine if you’re serious about increasing your portfolio.
Before digging in, it’s important to understand the different commercial real estate classification systems. Here are the top five, covering asset classes to help you distinguish between what you might be investing in and what’s a multimillion dollar behemoth.
Assets & Classes
Call it classification arbitrage, or just classification snobbery to be tough on yourself. Whatever it is, it’s a great way to gaze disdainfully upon other people who invest in commercial real estate — or any other asset class for that matter.
On the surface, classifications can seem like more genuine differentiation. For example, investing in mobile homes versus apartment buildings can make for more appealing mobility or lifestyle. Or investing in industrial spaces versus retail presents newer options to buyers.
But these distinctions aren’t nearly as meaningful as what classes look like to investors. For example, investors will be able to determine how much additional tax they’ll be paying versus someone who solely buys single family or multifamily properties.
Classification systems vary across different markets. Take Kansas City for example. Realtycodes.com divides the building types (mobile vs. multifamily) and the tax valuation accordingly.
But beyond the specific tax classification system, there are other considerations when investing in commercial real estate. Let’s take a closer look at what factors contribute to a better value.
How Commercial Real Estate Investors can maximize returns
There are several ways to play the investment game. But most of us will probably be minimizing risk with some or all of these investment strategies. When investing in commercial real estate, you’ll need to do the same.
Here are five strategies that maximize returns, allowing you to make more money than you’re putting in.
1. Buy more than you can sell
It’s the saying that a dollar today is worth more than a dollar tomorrow. And it’s true for commercial real estate as well.
You don’t sell a building unless you can offer a clear value suggestion to a potential buyer at its current level. If you can’t do this, either drop the price or raise the sales price. The only way you can take your returns higher is by rehabbing the property.
To how to analyze the contracts. And of course, there’s the part of the whole that involves buying a property and managing that property.
How to Evaluate a Commercial Real Estate Deal?
What exactly are the parameters that determine if a property qualifies as commercial?.
The two main criteria are dependability and revenue. The potential use of the land and building the space will obviously determine if a property qualifies as commercial.
If not, then you could pursue an FHA loan, but that’s a detailed post all unto itself (much like as a primary home).
Refinancing on commercial real estate is also different from a residential or a commercial multifamily property.
How Commercial Real Estate Works
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Essentially, you’re selling the pieces of the project (the building, land, inventory) on a piecemeal basis.
The net revenue (or after renovation income) is the same; your project is just larger in scope since you now have additional contributors to cover the upfront costs. (Sure, at some point, these costs will become commercial financing, but this will be downstream.)
The sponsor will then split the revenue with the owner, described as a percentage of the purchase priceIf the sponsor splits it with the seller, that could have a positive connotation.
It’s important to note, the use of general or special purpose dollars is widely varied outside of the commercial real estate context. Within larger multifamily assets, this is common. And, more importantly, how you structure the deal.
I want to explore potential commercial real estate opportunities, break down the numbers and get a better understanding of the pros and cons of each.
Commercial Real Estate Investment Numbers
The purchase price for a single family home or small multifamily applicable to a higher cost of living area is typically higher. With that said, this can change depending on factors such as natural resource location or future growth.
The Purchase price for single family homes is $300,000. For a condo that includes apartments, it can range from $360,000 to $400,000.
For commercials, it is not uncommon to need to trade for a higher price than $300,000. Commercials above the $5M mark can require negotiation.
Gross annual income (NOI)
Gross Annual Income for Single Family Homes is $580,000 whereas for Condos it can be as high as $2.4M per year.Using the above examples, you will come up with a rough figure of $1.6 to $2.7 million for commercials.
For single family homes, your total income will include the rent from the individual units, however, for condos, there is a complicated formula that determines the yearly income.
For condo owners, there is a 7.5x multiplicative factor as opposed to single family homes where the formula results in 7.5x gross annual income. This multiplicative factor is the result of how various units of real estate can contribute to gross annual income.
Gross Potential Rent (Rise)
Rise for single family homes can range from $720,000 to $1,440,000, whereas for condos, it is $140,000 to $260,000. This can affect the basis on subsequent purchases—try to price it at a higher price. So, personally, I priced my condo at $260,000.
The number of units times the average gross annual income in a given area. So if the average gross income is $2,000 per unit, the number of units times that number is 1,000 times that figure.
PRO TIP: For units, the above is very general, but real life can be more complex. Below has more detail on the different commercial numbers. Richard Feeney has a great article on calculating potential income for commercial buildings.
Realtor Marketing Specialist & Navy Veteran
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