Commercial Real Estate Investment
Are you wanting to explore commercial real estate investing but worried about the high bar for entry? You may have tried your hand at residential real estate and are tempted by prospects of the more significant and more steady revenue streams typically found in commercial real estate investments. If you think commercial real estate investing is just for those that already possess large amounts of investment capital, think again!
There are a few ways retail investors with some real estate investment experience can get a foothold in the world of commercial real estate. This article will discuss how you can pool your investments in a real estate investment trust (REIT) or a private equity firm to see stable, predictable returns on your investments.
Before we get into how– let’s define some terms to help you learn how commercial real estate differs from residential real estate.
Commercial Real Estate Terms You Need to Know
If you have some experience in residential real estate, you may be aware of some of the valuation methods used by investors to compare similar properties. The most familiar method is the comparable sales method, and it relies on market factors to adjust the value of a residential property.
However, commercial real estate valuation methods do not focus on market factors but instead on projected income generated by the property.
Capitalization Rates and Net Operating Income (NOI)
Capitalization rates, or cap rates for short, is the most common method used to project the profitability of a commercial property. Cap rates in commercial real estate are calculated by a simple equation that puts the NOI over the total purchase price. The NOI is an estimate of the yearly income minus all the projected operating expenses.
Cap rates are used to compare the annual profit of similar commercial properties. They are not the be-all-end-all metric, but they are a valuable tool in the commercial real estate investor’s toolbox. If you have an interest in commercial real estate, you need to become aware of this valuation method, as it will be the front runner amongst investors when comparing similar properties.
How You Can Invest in Commercial Real Estate
Since we have defined important terms, we can look at how you can start investing in the commercial real estate market. The following methods are the most frequently used by commercial real estate investment strategists.
Some are more hands-on regarding the amount of research, work, and time you have to commit, while others are trusts or private equity firms that do much leg work. Options like these bring investors the closest to a passive income stream, but that phrase is misleading.
Normally, to be a direct investor, you and a handful of other investors get together to buy a commercial property directly. You and your partners have to create an LLC, and by doing so, you basically create a small business whose function is to manage, market, and administrate a commercial property.
This method is the most time-consuming, involves the most risk, and is a full-time job of its own accord. It is the least “passive” of commercial investment choices, as your LLC must find the commercial property, negotiate its purchase, market to tenants, draft leases, manage and maintain the property, and so on. This approach perhaps isn’t the way to go unless you want to be a committed commercial property owner.
Real Estate Investment Trusts (REITs)
If you do not have the capital to invest in commercial real estate as a direct investor, you can pool your capital in a REIT. REITs are companies that run solely to invest, own, and operate commercial properties. There are umbrella REITs that handle many different kinds of commercial properties, and there are more industry-specific REITs that focus on restaurants or condominiums, for example.
REITs can be publicly or privately traded, meaning you can invest in them like stocks if they are public, but you have to be an accredited investor to trade in private REITs. Because these companies do practically all of the leg work– the research, development, and implementation of investment strategies– you’ll have no say in the choices and direction of the company.
Real Estate Mutual Funds
Real estate mutual funds are similar to REITs in purpose but differ drastically in function. They are similar in that both REITs and mutual funds pool investor money into real estate investments. However, the difference is in how they go about allocating their investors’ capital. Where REITs are companies that own, operate, and manage commercial properties directly, mutual funds invest in other companies that own, operate and manage commercial properties.
Investing in a mutual fund takes away the added step of researching REITs and other companies that directly manage the property. Though this means less work for the investor, there is an added layer of separation between the investors and the commercial property, as they are investing in companies who exist solely to invest in other companies that own, operate, and manage commercial properties. If this sounds complicated, it’s okay! It is.
Private Equity Firms
Private equity firms are another type of business framework that generates passive income for its investors. As far as investors are concerned, it is similar to a REIT but is always private, open just to accredited investors. Private equity firms differ in that some provide a unique structure– the individually syndicated deal.
This gives investors a say in the investment decisions. They have chances to invest in certain properties via the private equity firm. They have access to property information, including tenant info, and also have a greater degree of control over which projects their money goes toward.
Opportunities for Every Type of Investor
If the world of commercial real estate investing is new to you, it might seem overwhelming. However, the fact that there are several different ways you can invest in commercial real estate means that there is an investment opportunity for every kind of investor. Whether you are a laid-back retail investor or would like to become a more serious investor, the commercial real estate world is big enough for all sorts of investors to get a piece!
With Mission First Capital, you can start your investment journey alongside other military members and veterans! If you have questions or would like to talk about potential partnerships or investment opportunities, don’t hesitate to reach out. Give us a call at +1 (844) 632-3863 or visit our website MissionFirstCapital.com to learn more and let’s invest today!