Investing can be as simple as putting money aside in a bank or as complex as trading stocks on the stock exchange. The complexity of the mode of investment determines the amount of time and effort expended. For those looking for long-term investments, real estate investing is an option to consider.
One of the five major types of real estate investments is commercial real estate. Here’s how commercial real estate works and how you can use it to diversify your portfolio.
What Are the Benefits of Investing in Commercial Real Estate?
A commercial real estate investment typically necessitates a large sum of money, which no single retail investor can provide. Real estate investment trusts (REITs) and fractional ownership are the two most common ways to invest in commercial real estate (CRE).
Fractional ownership: This encourages like-minded investors to pool their investment funds and purchase an asset. The minimum ticket size is usually in multiples of lakhs. Individual retail investors can own one or more fractions of an asset, granting them a portion of ownership, based on their risk tolerance and funds. Rent and capital appreciation returns are paid out in proportion to each investor’s ownership. You have complete control over the asset with fractional ownership. In fractional ownership, you can continue to invest in other profitable assets while stopping, selling, or trading your ownership fraction of a non-performing asset for another.
How Should You Approach Goal-Based Commercial Real Estate Investing?
Goal-based investing works almost exactly like any other traditional investment model. CRE is an excellent long-term investment option. So, if you want to invest for less than three years at a time, you should probably look elsewhere.
Long-term investments have larger, well-planned goals that are spread out over five years or multiples thereof. Commercial office space is the simplest and most readily available option for investing in CRE at any given time, closely followed by warehouses. The rarer variety can be found in laboratories, manufacturing plants, or assembly lines.
Office Spaces: Office spaces are generally stable investments for at least four to five years if the company has not established a head office or corporate office. In such cases, the lease term could be extended to ten years with the option of renewal at the tenant’s request.
Warehouses: General-purpose warehouses store goods in transit, serve as a supply hub, or assist a nearby manufacturing or industrial unit. You can be confident that the investment will be stable for a long time, such as 15 years, if the tenant is a well-established e-commerce player and the surrounding business is strong. If not, most warehouses have a five-year lock-in period and a lease term of 11-12 years.
Tenants in the last category of manufacturing, research, and industrial spaces, whether laboratories, manufacturing units, or assembly floors, rarely leave. The only time you can invest in them is when new assets become available or a tenant decides to sublet a portion of the asset. The occupancy rate is rock solid, with tenures of 20 years or more. Capital appreciation is consistent, and rental returns are continuing. If nothing, you can simply give your commercial space for rent and earn a good sum of monthly income with the same.
You can invest in any of these subclasses based on your ideal financial goal, depending on what you are looking for.
What Should You Think About Before Investing in Commercial Real Estate?
As with any type of investment, proper research should be conducted into the critical factors for CRE assets. Here are the top factors to consider before investing in commercial real estate:
- Area
The location of your asset has a significant impact on its performance. This is true for both residential and commercial real estate.
Accessibility via roads and railroads, major highways, proximity to airports and seaports are all factors that can make or break the asset’s value and its ability to appreciate over time. A well-connected location near harbours and ports could be ideal for tenants who manufacture and either export to or import from other countries.
Businesses dealing with software operations will not benefit from the same location. When investing in a major urban market, keep an eye on the micro-markets surrounding the asset of interest for any changes that could affect your investment.
- ownership
Existing tenants, their financial situation, and the terms under which they are currently leased can tell you a lot about the asset’s long-term viability and the extent to which your investment will be beneficial.
Historical data on lease terms and vacancy will give you an idea of what to expect if there is a vacancy during the period you decide to invest. A general-purpose office space is more likely to be occupied than a special-purpose warehouse or laboratory. However, the latter can outperform the former in terms of capital appreciation and tenancy stability.
- Market Trends
True, commercial real estate does not experience the same market fluctuations as most other traditional investment options. However, market changes have an impact on the vacancy rate, rental rates, and occupancy stability. The Covid-19 pandemic provides an excellent example. Many markets saw drops in commercial office space rentals as a result of people not going to work in office spaces.
Keeping an eye on which businesses are causing a stir in the economy is a great way to figure out which commercial real estate asset you should be looking for next.
- Documentation
If you are investing in commercial real estate on your own without the assistance of an advisor, it is best to have adequate legal support to walk you through all of the legal paperwork to check for any hidden charges, ambiguous ownership clauses, and so on.
If you choose to invest in CRE through a REIT or fractional ownership, the majority of the above factors will be handled by the team in charge of the investment, sale, or resale of the assets. The most important thing you’d have to do is set a goal for what your investment should accomplish.
