How to Invest in Commercial Real Estate
This post was sponsored by Jamestown Invest, a digital platform that connects nearly anyone to rigorously-vetted, institutional-quality commercial real estate investments.
You’re at the point in your investing journey where you’re eyeing the commercial real estate (CRE) market, and wondering whether or not it’s a feasible way to earn passive income. You just need some direction to figure out how to get started.
Fortunately, you’ve come to the right place. In this post, we’ll provide you with tools to assist you in starting to explore this exciting asset type.
First, let’s take a closer look at the current state of the CRE market, which has been significantly impacted by the COVID-19 pandemic.
Assessing the Commercial Real Estate Investing Market
As Deloitte recently pointed out in a benchmark CRE study, most buyers and sellers are taking a wait-and-see approach to CRE right now, which is delaying deals across the board — and brokers are feeling the impact.
Fortunately, Deloitte said, the CRE industry was in a stronger position than the 2008 downturn heading into the pandemic as balance sheets, capital availability, and liquidity were all generally healthy — meaning companies could manage their debt maturities.
Still, the commercial real estate market was impacted almost immediately when the pandemic hit in early 2020. Vacancy rates particularly in hotel and retail assets started to climb as businesses were shut down by authorities. By March, nearly 74 percent of respondents set aside their CRE investment plans — and 63 percent said they were worried about property appraisals.
With that in mind, investors shouldn’t necessarily be afraid of the pandemic market right now. Rather, it’s a good idea to be smart about what type of industry you are investing in.
For example, investing in a specialty retailer or a shopping mall could be a risky play, unless you can get a great buy-low opportunity and you have the capital on hand to wait for the market to rebound. On the other hand, investing in a business like a data center could potentially yield an immediate annual return.
The big thing to keep in mind is that right now, the pandemic is still going on — meaning you should be on the lookout for deals but cautious about how this will shape out, at least through 2021.
Now that we have covered the present state of the market, let’s explore how you can incorporate CRE into your investment portfolio.
Why Invest in Commercial Property?
Up until recently, commercial real estate properties have not been an easy-to-access asset class for everyday investors (more on that below). However, it is starting to open up more thanks to companies like Jamestown Invest, which are making it easier for investors to get started.
Now, real estate investors have more options at their disposal. Some investors are choosing to diversify their portfolios by investing in both residential and CRE. Others are choosing to make the full leap into the commercial investment property space.
You may find that CRE has some enticing advantages to offer over residential real estate. With that in mind, let’s take a look at some of the top benefits of investing in CRE.
1. Stable Cash Flow
One of the advantages of investing in CRE is that you are dealing with businesses instead of homeowners — meaning you may receive stable income as long as you have tenants. Of course, there are exceptions as many owners learned during the pandemic when dealing with restaurants and similar businesses that were forced to either shut down or limit operations.
In general, as an investor, it may pay more to be involved in CRE, especially if you have prime office space. If your tenants have an exemplary track record and pay their commercial leases on time, you may be in a more solid position.
2. Appreciation Benefits
CRE also offers an opportunity for value capital appreciation, assuming that the property is well-maintained. This can occur from general upgrades and property maintenance. It can also occur due to changing market conditions.
For example, suppose you invest in a cheap warehouse in a part of town that is up and coming (think Williamsburg, New York before Brooklyn became the epicenter of the city). If you time your investment right, by luck or skill, you could wind up making a fortune over time.
Speaking of New York, there are over 8,200 residential for-sale listings on the market in Manhattan right now, which is the highest since 2011. That said, prices haven’t plummeted yet despite the increase in supply.
3. Tax Advantages
Another reason to invest in CRE is the multitude of short-term tax advantages that you can tap into. For example, interest from commercial mortgages is tax-deductible. You may also benefit from depreciation. And sales of commercial properties are typically taxed at lower rates, too.
In addition, CRE investors can benefit from something called a like-kind exchange, which allows you to exchange properties with other investors without reporting a large taxable capital gain.
Real Estate Investment Trusts (REITs) avoid double taxation as long as they distribute 90% of the net income on an annual basis, and many investors qualify for a 20% tax deduction on dividends from REITs based on the 2017 federal tax reform act.
Such investments are now available through qualified self-directed individual retirement accounts (IRAs), allowing investors to allocate a portion of their tax-advantaged long term retirement savings portfolio into commercial real estate.
These are just a few of the many tax advantages that you may experience when investing in CRE.
Of course, investing in commercial real estate is speculative and can involve substantial risks that can lead to partial or complete loss of invested capital, so it’s important to do your homework before investing.
Investing in Commercial Real Estate: The Basics
Here are some basic things to keep in mind before diving into the market.
A building has to meet specific criteria in order to be considered a commercial space. This is important for health, zoning, and tax regulations.
In order to be considered CRE, a building must be used exclusively for retail and business purposes. In other words, you can’t purchase a piece of property for commercial use, capitalize on tax benefits, and then turn around and rent it for residential use. This also holds true when purchasing undeveloped land.
In some cases, you can buy a residential property and convert it into a commercial property or a business, if local regulations permit and you can get zoning approval. It largely depends on the local restrictions of your community.
The Five Types of CRE
There are five types of commercial property types including:
Examples include warehouses, manufacturing sites, and distribution centers. Industrial uses can make excellent investment opportunities because many of these sites may be more resistant to economic downturns.
Retail properties can include indoor and outdoor shopping centers, restaurants, financial centers, and entertainment facilities. These real estate assets might encompass hundreds of thousands of square feet of retail space.
Office space is one of the most widely prevalent and lucrative types of real estate. They can range from small office buildings to large facilities. Depending on their size and function, office spaces are usually classified as Class A, Class B, or Class C.
Class A Office Space
This usually describes the newest and best quality buildings in the market. Class A buildings feature the latest infrastructure and design and are optimally located in the best economic areas.
Class B Office Space
Class B office spaces are older and less efficient than Class A facilities but are still good quality and in a decent location — although slightly less lucrative than Class A offices.
Class C Office Space
Class C offices are generally fixer-uppers, located in areas that are less than desirable. It’s generally difficult to attract premier clients to Class C facilities without making significant upgrades or offering dirt-cheap rents.
Early-stage CRE investors are sometimes surprised to learn that certain types of residential rental properties can count as commercial facilities. For example, this may include high-rise condominiums or apartment buildings. In order to be considered a multifamily property, a building must contain at least four separate living units.
5. Specialty Properties
Certain types of buildings are designed in a way that binds them to a particular use. For example, think of a gas station. It would be very difficult or expensive to take a used gas station and turn it into a restaurant. Other examples include stadiums and arenas, movie theaters, car dealerships, and aquariums.
Getting Started with CRE
Now that you have a better idea of what CRE encompasses, let’s turn our attention to what, specifically, you can do to get started.
Outline Your Goals
First, spend some time thinking about your overall goals and develop a strategy that helps you achieve them. Specifically, determine the net operating income that you want to achieve, the purchase price that you can afford, and the geographical areas that might help you accomplish those goals.
For example, if you are looking to invest in a commercial marina, you may want to explore real estate deals where the commercial fishing industry or private boat market is thriving, like Florida or Texas. With other industries, it may be possible to be a bit more flexible about location.
People may tend to travel more for services like excellent restaurants. For other services, like banks or convenience stores, the location might matter more.
Create an Investment Strategy
Consider meeting with a financial advisor and outlining a plan before you make any purchases. Remember that CRE, like residential real estate, is all about staying in the game and improving your situation.
You want to think about buying a commercial property that will set you up for success years down the line. A financial advisor may be able to look at your overall financial situation and give you a good sense of what to buy now, to avoid running into potential issues that could set you back years. A financial advisor may also be able to determine your overall risk tolerance and weigh it against current market conditions.
Determine How Involved You Want to Be
Next, you’ll want to think about what type of owner you want to be. Are you a hands-on type, that wants to own your own commercial building and handle all aspects of the lease agreements, zoning applications, health regulations, and so on? Or do you simply want to invest in a company that will handle that for you?
It depends on what you want out of your commercial investment and where you want to go moving forward. If you’re looking to take a hands-off role, where you don’t have to worry about a tenant fulfilling their lease terms, then it’s a good idea to explore your options. There are many opportunities available ranging from real estate IRAs, exchange-traded funds (ETFs) and hard lending to crowdfunding real estate and real estate investment trusts (REITs).
This is where Jamestown Invest comes into play. Jamestown carefully vets market opportunities and pairs investors with value-add opportunities while managing all aspects of the investment — from acquisition to management and everything in between. Jamestown can get you started in commercial real estate with just $2,500 — in a few simple steps.
It’s a good opportunity for passive investors who care more about putting their money to work than managing the work themselves.
About Jamestown Invest
Jamestown Invest is a digital platform connecting nearly anyone to rigorously-vetted, institutional-quality real estate.
Investing with Jamestown may be an excellent way to diversify your portfolio, and invest alongside a stable, reliable, and trusted manager with $11.8 billion of assets under management worldwide. Jamestown works with over 80,000 investors across 31 realized funds.
Traditionally, CRE has only been available to accredited investors and institutions — meaning not everyone could take advantage of market opportunities. Jamestown is revolutionizing the CRE market by democratizing the process and opening the industry to more types of investors. This, in turn, is opening CRE to more investors, which benefits the overall market and individuals like yourself who want to expand into new opportunities.
Is CRE Risky?
CRE can be a risky investment vehicle. As with any investment, diversification may reduce your risk.
Jamestown will work to identify solid, long-term investments that typically have a five to seven-year holding period. You can get started with as little as $2,500, and grow your potential for income over time if properties generate sufficient cash flow.
Remember: All investments carry some level of risk. As an investor, the trick is to do your due diligence to mitigate your risk as much as possible while positioning yourself for better returns. CRE is a way to accomplish this.
Can You Occupy Your Own Commercial Property?
Most business owners choose to rent their commercial properties. However, over time their needs may change and they may choose to buy their space outright.
For example, a business may choose to do this to have more control over building operations or to prevent potential competitors from moving into the same building. Or the business may simply get tired of paying rent.
When a business decides to own and occupy their own space, the space becomes owner-occupied commercial real estate (OOCRE).
Is CRE Expensive?
CRE can be extremely expensive, depending on the type of property that you buy. Property taxes, operating expenses, property management fees, and maintenance costs are just a few factors to consider. CRE is usually more expensive than purchasing single-family homes, and a property owner must be prepared to take on the financial responsibility.
That said, many of these costs can be reduced or eliminated by opting for triple net leases, or investing through a private group like Jamestown pooling the capital of many investors. Investing in CRE is always risky, but risks and costs can be reduced if you know where to look.
What’s Better: Commercial or Residential Real Estate?
It largely depends on your goals and ambitions. For some people, investing in CRE is worth every penny because they get to work with small businesses and be an active part of their local economy. Other investors prefer to work with individuals and therefore feel more comfortable in the residential market. For still others, multifamily real estate offers a perfect blend between the two markets. It can also be easier to finance than other types of real estate.
You know your risk tolerance and interests better than anyone else.
You might also enjoy reading Commercial vs. Residential Real Estate Investing.
Investing in Jamestown Invest 1, LLC’s common shares is speculative and involves substantial risks. The “Risk Factors” section of the offering circular contains a detailed discussion of risks that should be considered before you invest. These risks include, but are not limited to, illiquidity, complete loss of invested capital, limited operating history, conflicts of interest, blind pool risk, and any public health emergency. In addition to the foregoing risks, the adverse economic effects of the COVID-19 pandemic are unknown and could materially impact this investment. Further, there is no assurance that Jamestown Invest 1, LLC will be able to achieve its investment objectives or to access targeted investments like those identified. Securities offered through North Capital Private Securities member FINRA/SIPC.
The views expressed above are presented for educational and informational purposes and are subject to change in the future. This communication is not to be construed as investment, tax, or legal advice in relation to the relevant subject matter; investors must seek their own legal or other professional advice. Certain information presented or relied upon in this presentation may have been obtained from third-party sources believed to be reliable; however, we do not guarantee the accuracy, completeness or fairness of the information presented.