Investors, both institutional and private, have begun to favor Commercial Real Estate (CRE) due to its great returns and investment portfolio diversification, which safeguards assets from the volatility of the market. However, investing in CRE isn’t a cakewalk, and being acquainted with the unwritten rules of CRE dealings is a good idea.
Expected Returns on Commercial Real Estate ROI
As it is with all sources of income, the basic feature of regular flow is always there while investing in CRE. Along with that, it has, some innate features which are:
An investor looking for a continuous and periodic income can expect attractive rentals. Rental yields gained from CRE investments are 7-10% per annum, and better locations and asset quality can boost this figure.
Commercial property leases are longer compared to residential properties and ensure fixed cash flow. And an investor can easily expect a return range of 12-20% on his initial investment.
Higher rental rates on commercial properties are good investment opportunities to earn regular income as they offer higher rental rates compared to residential properties. These returns are higher than fixed deposits and at par with AAA-rated bonds issued by blue-chip companies.
Cash Flow Opportunities
Commercial property that has space for tenants can help in generating wealth through rental income. Tenant income can be used to pay the property purchase, thus offsetting the cost of the investment.
An investor can also avail of tax benefits and several tax reductions designed for the business or property owner. Be sure to consult a financial advisor to understand tax schemes and their effect on particular circumstances fully.
Asset diversification can help maximize returns since different investments react differently to the same event. The current market is prone to uncertainty, and apart from security, diversification provides stability despite the ups and downs of the market. And CRE provides a great means to diversify one’s asset portfolio.
Uninterrupted wealth flow is the goal of every investor, and investments in CRE achieves this. A high degree of security is also promised since this investment is spread out over time. Tax benefits and reductions also ease the process of investment and encourage investor loyalty.
Maximizing Returns from Investments in CRE
To generate profit consistently over the years to come, keep a few points in mind while investing in CRE.
Returns on commercial properties are mainly due to rent and capital appreciations, which heavily rely on the location.
Be on the lookout for locations that have a vacancy of less than 5% since it discourages tenants from moving and renegotiate rents. Look for commercial hubs that have all the amenities that street retailers or corporate offices may want.
Getting an Anchor Tenant
A mall can have an anchor tenant as a departmental store of a global or national chain. A noteworthy bank or a Fortune 500 company can be an anchor tenant for an office building.
An anchor tenant can be instrumental in luring other prospective tenants to your project and, ultimately, its success in the long run.
To find an anchor tenant, comb through classified listings on real estate portals. You can even contact companies directly and ask them about their expansion plans in the city and plan your property investments accordingly.
Staying Updated with the Current Demand and the Upcoming Supply
It is important to keep tabs on the historical demand and projected supply in the future through published reports on the same. Careful analysis and gauzing the micro-market of an area can help make informed decisions.
Terms and Conditions of the Lease
Commercial lease structures are structured as 9 years or 15 year leases with escalations every 3 or 5 years. The tenant holds power to vacate anytime, i.e., the leases are one-sided. Sometimes a lock-in period can also be agreed upon during which the tenant cannot vacate the property.
A longer lock-in period is more profitable for the investor. Keeping this in mind and the structure of the lease, one must settle upon the terms of the lease respecting the interests of both parties.
Features of the Building
The inherent features of a building can influence rents, capital appreciation, and tenant retention. Certifications like LEED gold/platinum ratings can attract global tenants who are quite willing to pay a percentage for high-end quality and services. Higher quality properties also tend to be more liquid and get sold swiftly.
Good locations will attract better tenants and eventually lead to the triumph of one’s investment endeavors. It eventually boils down to your knowledge of the market and skills in assessing various factors, which will help you increase your returns.
Common Mistakes that can hamper CRE Returns
A big-ticket investment needs to be handled with adequate caution since there is a lot at stake. To make sure you get the best of your investment and avoid mistakes, there are some things that you must bear in mind.
- You should carefully examine the property you choose to invest in. Sellers and brokers may try to swindle a deal out of you by taking you only to the best parts of the building, free from damages or ruin of any kind.
- You must insist upon checking the entire building so that there are no impending repairs that the seller is trying to pass off as a repair burden.
- Some areas have environmental laws that don’t allow certain activities in that zone. Investing in a particular locality to carry out certain businesses only to find out that the activity is not allowed in that zone can be tragic. Your returns will be inadvertently affected.
- Pressing your broker for details before the deal is cut and dried is a must since it is quite likely that he would refrain from even talking about the limitations in the first place.
- Hiring an expert and cross-checking with a neutral broker before making anything final is considered a good idea.
Real estate investment becomes more of a science than art if there is careful planning and forethought involved. In the beginning, it may seem daunting to generate good returns. But once you grasp the core skills involved, you will surely find success. All investments are linked with some form of risk. Finding techniques to alleviate them is an invaluable skill for an investor. This skill eventually improves with time as one gets acquainted with the tricks of the trade.
Investing in commercial real estate sector, though a time-consuming process, surely comes with its own set of benefits. Consistent and passive income, portfolio diversification, and growth potential are few reasons why investors should consider CRE. Setting fixed goals and exercising the right amount of caution and patience will result in the fulfillment of your financial pursuits.
Commercial Real Estate ROI FAQs:
The type of the investment property is going to largely determine what you can expect. Several others factors are involved but 10% is a good rule of thumb.
You can surely anticipate the returns to get higher in riskier investments. If you buy during recession, ROI can get as high as 20-30%.
If you know what to ask while reviewing potential agents you will be able to zero down on a qualified agent with whom you will also be comfortable working with. A good agent is only going to make life easier for you.
Here are some points on which you can build your enquiry on.
- Expertise of the agent in dealing with your business’s property type
- Fees and commission rates of the agent and brokerage
- Reputation of the firm
- The agent’s attention to detail and responsiveness
- Honesty on part of the agent
You can also gain additional feedback from people who have worked with the agent or brokerage in the past. Refer online reviews if needed.
While it is not necessary for a buyer to get a broker, hiring one will allow you greater access while viewing the property you wish to invest in. A broker will also help you go through the process of negotiation and get you a fair deal with the best possible rates and terms.
You may also consider looking at properties online but, the information will be quite limited compared to what a broker will be able to provide.
Contacting the seller directly is also an option. It will grant you access to the building and other additional particulars about the estate. But, it must be kept in mind that some sellers allow buyers to visit their properties only through a broker.
It is not possible to come up with a specific number that all brokerages go by and not every brokerage discloses their commission rates to the public except through enquiry. But you can expect it to be somewhere between 3-10%. It is quite negotiable and depends to a large extent on the market value of the property, the willingness of the buyer to pay and the brokerage itself.
Tenant improvements are customized alterations that are made to a rental space in order to meet the needs of the tenant’s business motives. Usually the cost of the arrangements is borne by the tenant. The landlord may credit a certain amount.
However the arrangements can also be paid for by the building owner as part of the lease agreement.