Shopping malls, office buildings, warehouses, and hotels are properties you probably drive by nearly every day. They represent commercial real estate investment opportunities and assets you may want to add to your portfolio. You could be looking for immediate cash flow, long-term gains, or a mix of the two. Commercial real estate can diversify your existing assets while letting you learn more about the business.
But, of course, you don’t want to get in over your head. Commercial real estate comes with a distinct set of rules and variables compared to residential. Financing requirements, projected cash flows, and lease agreements all look a bit different on the commercial side. If you want to find ways to unlock success with commercial properties, confer with someone you trust who has experience. Here are four tips to get you started.
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1. Keep An Open Mind
First impressions don’t always turn out to be accurate. Sure, a pristine office building appears to be a good investment. But when you start digging into the numbers, you find the monthly cash flows don’t come close to your expected return. You’ll have to either lower your expectations or move along.
On the other hand, there could be something there you’re not seeing. Maybe you need to put some work into the property and change the leasing strategies. The property’s numbers could eventually turn around with a few modifications and fresh approaches.
While the national office vacancy rate increased to 19.2% in the third quarter of 2023, it doesn’t mean all opportunities were lost. Undoubtedly, some investors still did well with office investments or discovered ways to convert their spaces. When you’re considering what types of commercial properties to invest in, don’t let first impressions and aggregate data sway every decision.
For instance, do you automatically think mobile home parks aren’t a worthwhile investment? Your assumptions could cause you to overlook a solid commercial real estate opportunity, especially if you don’t think outside the box. When it comes to mobile home parks, Lifestyle Investing expert Justin Donald explains, “One of the most significant benefits is that you can often get sellers to finance it for you.” Seller financing can boost your cash flow and reduce risk.
2. Narrow Your Focus
Learning the ropes of commercial real estate is like any other subject. Overwhelming yourself with too much information and scope won’t do you any favors. You’ll be at risk of analysis paralysis or making decisions with generalized information. If you want to unlock success, it helps to narrow your focus.
In commercial real estate, a narrower focus often means learning a few asset types like the back of your hand. Maybe you’ll decide to choose to invest only in shopping malls while you’re learning. Maybe the shopping malls also include office space to bring diversification into the picture. By specializing in this asset class, you’ll amass knowledge of commercial leasing and property management requirements.
For example, you’ll soon discover how commercial and residential real estate leasing agreements differ. Residential tenants usually aren’t responsible for maintaining their unit’s HVAC equipment. However, this isn’t always the case with commercial lease agreements. It’s not unusual for tenants to bear the costs of maintaining and repairing the HVAC equipment.
Commercial tenants may also have to provide the landlord with evidence of a maintenance contract. Lease agreements for commercial spaces are also typically longer than residential ones. Anchor stores in shopping centers could have leases with 10-year terms or longer. Smaller spaces, including offices, could have shorter agreements. Concentrating on a few property types allows you to get good at spotting industry norms and prime opportunities for cash flow.
3. Watch For Market Changes
Commercial real estate is like residential real estate in terms of market changes. Those fluctuations are almost a guarantee. There will be ebbs and flows over time. Market changes are forces you can’t ignore because they can impact your success.
Say prices are rising fast. Your fear of missing out could lead you to invest in overpriced properties that negatively impact your cash flow. What’s worse is you could end up with an overpriced property that needs a ton of work. You’ll put more money into repairs and renovations with the risk of not getting a return.
While you could sell the property and make it someone else’s problem, you might sell at a loss. Say the market suddenly cools, and average prices drop considerably. You might not have the means to hold your property until values increase again.
The subprime mortgage crisis that occurred from 2007 to 2010 is an example. An astonishing $3.4 billion in real estate wealth was gone. Many homeowners and investors found themselves underwater. Although the subprime mortgage crisis is a more extreme illustration of what can happen, understanding market trends is important. Do your due diligence to make sure a property fits your budget and investment goals.
4. Understand Sellers’ Motivations
When you’re negotiating commercial real estate deals, understanding what’s driving sellers can give you an edge. Being able to find motivated sellers helps, too. People who are highly motivated to sell a property may be willing to negotiate a lower price or seller financing terms. Understanding where sellers are coming from puts you in a better place to get a favorable deal.
It also helps you start on the right foot. You don’t want to approach a potential seller who isn’t interested in accepting offers below specific price points. If you go in too aggressively, you could offend the seller and shut down chances at negotiations. Consequently, you lose out on a coveted property.
Understanding a person’s motivations could also open doors to partnerships. Maybe a commercial property owner isn’t interested in selling completely. However, they’d be open to sharing responsibilities and returns with other investors. If you’re open to real estate syndicates, you can share the risks and rewards of commercial real estate investments. You’ll still want to do your research, crunch the numbers, and evaluate those opportunities against your goals.
Unlocking Success In Commercial Real Estate
Commercial real estate isn’t the same ballgame as residential. While there are similarities, there are also a different set of standards. Achieving a set of home runs isn’t guaranteed, but there are steps you can take to increase your chances for a positive outcome. Be open to unconventional opportunities, but not so open you ignore market signals and your investment goals. In addition, narrow your focus so you can learn when it’s best to play within and outside industry standards.
