Should You Invest in Commercial Real Estate?
Commercial real estate entails the occupation of a place for revenue-earning purposes or using it as a workspace. It is generally rented out to tenants or left on lease to people on the lookout for a place. Commercial real estate can be categorized into three categories:
- Class A comprises of the best buildings in terms of it aesthetics and location
- Class B are older buildings than Class A and doesn’t generate enough competition among buyers.
- Class C are buildings that are dilapidated and require frequent maintenance.
Reasons To Invest In Commercial Real Estate
- With CREs you can actually own property that will enable you to obtain financial security and a steady income in the future.
- In case you cannot afford a single ownership of an estate, you can pool in funds and form a limited liability corporation where the capital involved and the risks associated with it are less.
- When you invest in CREs your investment portfolio is diversified. This means even though there are lot of markets to invest in real estate is the most stable and non-volatile amongst them.
- Inflation is going to skyrocket the prices of property as well just like it acts on articles of daily consumption so the owner is able to maintain his standard of living even though the economy is behaving abnormally.
- There are potential tax benefits associated with CRE ownership taking into account things like depreciation and maintenance.
Who Can Invest In Real Estate?
Ideally speaking people with a limited amount of resources cannot invest in real estate but today due to LLCs a lot of people own a stake in one establishment. People who have been in business and want to establish a wider array of holdings can invest in real estate. There are some people who see this as an opportunity to generate stable cash flow for the future and hence consider this as a post-retirement option. New and aspiring businessmen today are branching out to commercial real estate to gain experience as a property owner and landlord.
When Should You Invest In Commercial Real Estate?
According to studies, commercial real estate demands, unlike residential properties are always on the rise. Let us take a thorough look at the factors associated with investment on commercial real estate:
- The initial consideration should be all about the subjective interpretation of the entrepreneur. If his willingness to take risk is high and he has a general idea about how much he wants to invest, he should go forward with the investment. An investor should also be clear behind the reason of his investment.
- The second thing to take into consideration is the location of the real estate property. If the location is upscale the demand and price for the property is going to appreciate more than similar properties. The lease contracts and how long the lease holds true should also be considered.
- Ultimately it is important to strike a fine balance between the risk and its returns. Most experienced investors prefer using a stable income generating source over quick income generating source. Smaller investors should not invest without proper counsel.
Factors Determining Real Estate Investments
- Demand and Supply: A street smart investor has to analyze the market before committing head first into any investment project. Every small market has its own array of finished products and unfinished products. However, in case of huge rise in supply of the stock of projects, the price is bound to come down and in case of an atrocious rise in demand, the price of the properties is going to shoot up.
- Tenants: A good investor will always look for quality tenants. Multinational companies in the form of tenants are going to increase the value of the property and pay their rent on time. They are also more likely to take longer leases and pay better deposits to appreciate the value of the property.
- Interiors: Who takes on the responsibility of doing the interiors can also contribute to the length of the lease. Generally, offices in India are provided to the tenant without any furnishings. The wiring and the electrification, ceiling and air-conditioning are done only after occupancy. A tenant can ask an investor to do the furnishings which the investor covers with added costs. However, a smart investor would ask the tenant to do his own furnishing. When a tenant commits to the furnishings he is likely to stay longer to recover his investment.
- Understanding the Difference between Base Rent and Fit out Rents: Builders often try to be wily to the investors by confusing them between basic rent and fit out rent. They add the two components to add to the value of the property. Fit out rents are generally short term and stop being a part of the total value of the property. When the fit out rents get over, there is drop on the overall return on the property and the investor finds it problematic to get the property out on lease at a price that would enable him to break even.
- Understanding the Lease Structure Properly: Commercial lease structures are generally different from residential lease structures. It is either a nine-year or a fifteen-year time period. In contrast to residential properties, the tenants can leave at any time they deem fit and the investor will not be able to withhold their departure. There is a provision, however, of a lock in a period where the tenant will not be able to leave, say within the first three years. Ideally, the longer the lock-in period of the tenant, the more profitable it is for the investor.
- Understanding the Symbolic Implications of Security Deposit: Generally, when a prospective tenant offers the investor a security deposit that covers the rent of at least a year it is a good sign. This means he views this establishment as a long term option. If someone bargains with how many months’ worth of rent he is going to cover, it should be considered a red flag. This might imply that he is looking for a short term fix or there are financial problems that might become a problem in the long run, especially while trying to recover rent and maintenance rents.
- Diversification of Your Resources Is the Key to Success: Diversification brings in great joy for any investor. If an investor decides to commit all his resources in one establishment, then in the case of an unforeseen vacancy, all his revenue-earning sources will be blocked. On top of that, taxes and electric bills, and maintenance will still have to be paid regularly. So it is advised that a smart investor should try and get hold of different properties that pay well.
- Quality: In the end, everything boils down to the quality of the product. If two buildings are located in the same neighborhood, chances are the one that looks great with better amenities is going to get occupied sooner. More affluent clients like multinational corporations are always up for a great building with better views, fancy lobbies, and state of the art elevator facilities. Buildings that are certifiably better with LEED gold authentication will appreciate faster than an average building and while doing so will keep themselves in a better state of liquidity than others.
While investing always be aware of what the builder is putting in front of you as honest information. There are builders who deal in inflated prices and as such the sell price inflates. However, when you put it out on lease, customers who have probably seen every establishment in that macro market will try to negotiate with you to bring back the rent to its market price and that is when you will not be able to make any profit.
In today’s world commercial real estate will provide you with a stability that is unmatched in any other form of investment. Because of our tax laws, you can make more money every year but the amount of tax that you pay decreases every year allowing you to earn even greater profits. Corporate tenants today are much eager to stay as long term tenants with longer lock in years allowing you have a remunerative advantage for the foreseeable future. In today’s market of cryptocurrency, commercial real estate has become a symbol of tangible wealth.
Investing in CRE FAQs:
A mortgage is a deed that puts tangible property in the hands of the person paying money as a security and a deed of trust places obligation on the trustee to give back the property to the owner once the debt has been paid.
If as a buyer or seller you want to minimize costs then probably not. However, given the sophisticated nature of dealings it never hurts to have professional advice.
Brokers don’t give you legal advice so it is better to hire an attorney now than to get entangled in legal complications later.
Escrow acts as a professional third party convener of sorts and handle paperwork or title deeds and insurances.
A good title means that there are no shady dealings that have taken place with the concerned and the ownership is clear and not shrouded in mystery.
Even though there are no rules regarding it there should be the enlisted address of the buyer and the seller, title deed and title insurance, price of the property and payment structure.
As a potential buyer it would be might honest of you, if you did it now rather than exposing yourself and your employees to future catastrophes