What Type of Commercial Real Estate Investment is Right for You?
I often get asked how I first started investing in commercial real estate (“CRE”), and of course the next follow up question: “How do I start investing?” I think the most important facet to begin investing in CRE is to identify what your goals are. How much do you want to invest and why do you want to invest, is it to build equity; for cash flow purpose; or are you looking for larger future appreciation? CRE can provide an avenue of long-lasting income; it can help diversify your portfolio, it can offer tax benefits, and by using properly selected real estate strategies, it can produce the potential for appreciation, in addition to cash flow.
Many first time investors in CRE immediately go to multi-family apartment buildings. Any multi-family building with 5 units or more is considered a commercial property. There is a comfort level for most people in that they are familiar with the leases, how they operate, and what a tenant might expect of a landlord. This asset class however, is one where the investor is typically very hands on with the investment. There tends to be higher turnover of the units (advertising for new tenants), make-ready of the apartment once someone has moved out, and maintenance issues (emergency calls in the middle of the night). An area many first time investors overlook is the budgeting for capital expenditures (roof or water heater replacement, repairs, etc...).
An alternative to an apartment building is either an office or retail building. The differences can vary widely. Office leases can be similar to apartment leases, in that the majority of the leases are either Full Service Gross, or Modified Gross. A Full Service Gross lease essentially means that everything is included in the lease; utilities, maintenance, even janitorial; while a Modified Gross lease is very similar to a residential lease, where typically the tenant must also pay for utilities and janitorial. Positives for an office lease are that the leases are typically 3-5 years long, and a tenant is typically responsible for the increase in the expenses over their base (initial) year. This of course reduces some of the risk. .
Retail leases are typically drafted under a Triple Net (“NNN) format, whereby the tenant is responsible for all costs associated with the space, including reimbursements for taxes, insurance, and repairs; and are also typically longer, from 5-20 years in length. This may offset some of the risks associated with rising costs, but retail buildings also have some negatives. You can offset these risks by leasing to established businesses, with corporate guarantees, and proven track records. Retail properties typically are the easiest to manage for an investor.
The easiest management option is the Single Tenant NNN building. This is a single building, occupied by only one tenant. An example of these would be most fast food restaurants, banks, drug stores, and grocery stores. Many times, these leases are structured with initial lease terms that are 10-20 years in length, with rental increases built in, and with multiple option periods. With a strong corporate tenant, and guarantee, this type of property can truly allow for a much lower, long-term investment risk. Due to the nature of these types of leases, you are able to easily invest out of the area to maximize your cash flow.
Ultimately, there are many options for a CRE investor, the right type of property for you is one that meets all of your goals and risk comfort levels. To find the best ones, make sure you utilize a good agent familiar with the asset class, which can help you identify the right property for you.