Commercial real estate diversification is in the back of every residential investor's mind. Whether you're looking to diversify or just tired of managing residential tenants, investing in commercial real estate might be a good strategy for you. An impending economic downturn is also a good reason to explore certain types of commercial real estate because they may be more resilient than other types of properties.
Making the transition from residential investing to commercial real estate investing can feel overwhelming, but it doesn’t have to be. Learn about what types of commercial real estate might be a good fit for you and how to finance them.
Types of Commercial Real Estate
Depending on the market conditions, there are a range of different commercial real estate investing options, including:
- Multifamily homes: Many investors dip their toes into commercial real estate investing by purchasing multifamily buildings with five or more units. This is a good transition from flipping individual homes or managing single-family rental units because you can leverage your experience and gain efficiencies with multiple units.
- Retail stores: The pandemic and the subsequent mass shift to online purchasing heavily affected the retail market. As a result, retail stores are in decline. This doesn’t mean they’re not a good investment, but you must carefully consider the location and type of retail store before taking the plunge. Consider essential or irreplaceable retail tenants when buying stores. You can't order a manicure or pedicure from Amazon.
- Offices: Demand for offices also took a sharp nosedive due to the pandemic and continues to decline. Although it will eventually level out, demand is not expected to reach pre-pandemic rates, creating a glut of office space in the market. In the near term, purchasing offices that are already occupied will be a safer bet than investing in vacant spaces. Developers might be interested in repurposing such buildings for other uses, such as apartments.
- Healthcare: Medical facilities and clinics will always be in demand and are replacing retail stores in some areas. Having a foothold in this area is often a sound investment.
- Warehouses: In the wake of the pandemic, companies are still struggling to find suitable space for e-commerce inventories, putting warehouses in high demand.
- Mixed-use: Buildings that combine residential units with retail, office, or restaurant space allow you to generate revenue from multiple types of tenants.
- Hotels: The success of hotel investments depends heavily on travel and tourism. This market is currently in recovery, so there is both opportunity and risk with purchasing this type of property.
- Residential developments: The demand for housing continues to grow, and development projects are a way to get more homes on the market. If you have experience with development, this could be another avenue to make money without needing to move any dirt.
Tips for Commercial Real Estate Investing
Commercial real estate investing can be lucrative, but it comes with some risk. Follow these tips as you start to test the waters.
Understand the differences.
If you’re used to investing in residential real estate, it’s important to know how commercial real estate is different. Leases last longer, often take a larger up-front investment, and it may take longer to fill a vacant space.
Consider the current market conditions.
Choose investments that are expected to perform well in the future. Although conditions will change, unless you have the capital to withstand long-term vacancies, it’s important to be mindful of current and future market demand.
Understand your location.
Every type of real estate performs differently depending on its location. A strip mall might thrive in one neighborhood and fail in another simply because of traffic patterns. Thoroughly research any property you’re considering and evaluate how the location might influence success.
Analyze comps.
Just as you would with residential real estate, you need to understand the value of similar properties to know whether you’re making a wise investment. Find out the value of similar properties that are selling and leasing.
Run the numbers.
Understand the costs to maintain the property and what a commercial lease requires of the owner. Budget for repairs and maintenance and include a contingency fund for unexpected costs. Make sure your property can be cash flow positive when you need it to be.
How to Get Commercial Real Estate Loans
Unlike a traditional mortgage, getting a commercial real estate loan from a bank is not always easy, especially if you don’t plan to use the property for your own business or if it’s vacant. However, many investors are interested in buying discounted properties or those that are not performing, vacant, or generating below-market rents because they will be cheaper and have a higher upside once fully leased.
The value of commercial real estate hinges heavily on both income and location. Banks underwrite these properties and loans using debt service coverage ratios. These numbers will not meet bank requirements if the properties are below market or vacant, which is where hard money comes into play.
If you find it difficult to get a commercial real estate loan from a conventional bank, a hard money lender is often a good alternative. Underwriting is simple and focuses primarily on the equity of the property.
Hard money might even be your first choice if you’re searching in a competitive market and need fast cash to make an offer. Hard money lenders don’t require the same in-depth financial analysis that conventional banks do. This means less paperwork for you and less scrutiny of your finances. Hard money loans also use property for collateral, so as long as you have equity and a good deal, you have a good chance of getting a hard money loan. The speed at which hard money can close is especially useful for investors who want to take advantage of time-sensitive opportunities. Closing in five days or less is common with private capital.
Commercial Real Estate Loans from Socotra Capital
If you’re considering commercial real estate investing, even as a first-time investor, Socotra Capital is an ideal hard money lending partner. You get fast access to cash—in as few as five days with our Turbo Close—and have more freedom to find the deals with the best upside. When you’re evaluating your lending options, keep hard money on the table for the most flexibility.
Seasons change, and so do investment opportunities. Read The Ultimate Guide to Navigating the Real Estate Market in Any Economic Season to learn how to decide which types of investment make sense at different times.
