How to Start Investing in Commercial Real Estate: A Beginner’s Guide

Investing in commercial real estate can be an extremely lucrative way to grow your wealth, generate passive income, and diversify your portfolio. However, it’s also more complex than residential real estate and has a steeper learning curve. This comprehensive guide breaks down everything a beginner needs to know about how to start investing in commercial real estate investment.

What is commercial real estate?

Commercial real estate (CRE) refers to properties used primarily for business, commercial, or income-generating purposes rather than residential living. Common examples include:

• Office buildings
• Retail centers like malls, shops, and restaurants
• Industrial properties like warehouses, factories, and distribution centers
• Multifamily apartment buildings
• Hotels, resorts, and other hospitality establishments
• Special purpose buildings like hospitals, schools, churches, etc.

The main distinction is that commercial properties generate income by being leased out to business tenants, as opposed to housing individual residential occupants.

Benefits of Investing in Commercial Real Estate

Several advantages make commercial real estate an appealing investment strategy:

• Higher Income Potential: Commercial properties typically earn rental yields between 6-12%, greater than the 1-4% earned from residential rentals.
• Longer Lease Terms: Commercial leases generally range from 3-10 years, providing more reliable long term income than 1 year residential leases.
• Triple Net Leases: Tenants often pay property taxes, insurance, and maintenance costs, reducing expenses.
• Portfolio Diversification: CRE investments diversify beyond stocks and bonds.
• Tax Advantages: Significant tax savings from depreciation and 1031 exchanges.
• Lower Costs: Commercial properties cost more but require fewer overall units to start earning substantial income.
• Appreciation: Properties can gain value over time, unlike stocks that fluctuate daily.

READ ALSO: A Beginner’s Guide to Real Estate Investment Groups and Crowdfunding

Types of Commercial Real Estate Investments

There are several ways to invest in commercial real estate as a beginner:

Direct Ownership

• Individual Property: Purchase an entire commercial building independently.
• Joint Ventures: Partner with others to jointly invest in larger properties.
• Owner-Occupied: Buy commercial space for your own company’s office or operations.

Indirect Investing

• REITs: Publicly traded companies that own commercial real estate assets.
• CRE Crowdfunding: Pool money with others to invest in properties online.
• Private Equity Funds: Invest in a fund professionally managed by a CRE investment firm.
• CRE Syndications: Join a group of limited partners in a commercial property investment.

Commercial Development

• Ground-Up Development: Construct a new commercial building from the ground up.
• Value-Add Investment: Buy an existing property, renovate it, increase rents.
• Adaptive Reuse: Convert an old non-commercial building into a new commercial use.

How to Get Started in Commercial Real Estate Investing

Follow these steps to begin investing in commercial real estate as a beginner:

1. Learn the Fundamentals

• Read books and take courses on commercial real estate investing to understand the basics.
• Learn about different property types, markets, and investment strategies.
• Understand how commercial real estate is valued and how to assess opportunities.

2. Analyze Your Market

• Research commercial real estate trends, prices, and vacancy rates in your local area.
• Identify growing markets and property types with strong fundamentals.
• Connect with brokers and landlords to gain market insights.

3. Determine Investment Goals

• Decide which types of commercial properties and strategies fit your goals.
• Evaluate your budget, time commitment, and risk tolerance.
• Be clear on target returns and timelines to guide decisions.

4. Find Investment Opportunities

• Leverage brokers to uncover off-market deals before they are listed.
• Network with local landlords, lenders, and brokers to find deals.
• Search property listings, loopnet.com, auction sites for opportunities.

5. Analyze the Deal

• Verify tenant demand and analyze local rents and vacancy rates.
• Conduct due diligence on leases, costs, taxes, zoning etc.
• Project returns using commercial real estate calculations.

6. Secure Financing

• Explore commercial real estate loans like SBA, portfolio, and non-bank loans.
• Negotiate favorable loan terms and interest rates.
• Leverage partnerships or commercial financing platforms.

7. Purchase the Property

• Submit a formal offer and negotiate contract terms.
• Perform final due diligence before closing.
• Close on the property and take ownership.

8. Manage the Asset

• Lease space in property to commercial tenants.
• Oversee vendors, maintenance, repairs, and leases.
• Collect rent and manage financing payments.

Key Differences from Residential Investing

Commercial real estate differs from residential real estate in several important ways:

• Bigger Deals: Commercial properties are larger and more expensive, often over $1 million.
• Higher Leverage: Banks finance up to 80% LTV for commercial vs 20% for residential.
• Longer Lease Terms: Commercial leases span 3-10 years compared to 1 year residential.
• Flat Rents: Commercial leases often have flat rents without annual increases.
• Triple Net Leases: Tenants pay property taxes, insurance, maintenance costs.
• Professional Tenants: Commercial tenants are businesses instead of individual renters.
• Zoning: Commercial properties require proper zoning approval for business uses.

READ ALSO: The 5 Main Steps in the Real Estate Development Process

8 Tips for Beginner Commercial Real Estate Investors

1. Start small: Begin with a smaller multi-unit or office building to get experience before diving into larger properties.
2. Learn before you leap: Invest time upfront fully understanding commercial real estate before investing significant capital.
3. Choose the right location: Location is key – research population growth, jobs, infrastructure, and demand generators.
4. Analyze cash flow: Verify stable occupancy and rents exceed costs to generate positive returns.
5. Mind due diligence: Rigorously assess leases, costs, zoning, environmental and property conditions before purchasing.
6. Build your team: Work with experienced commercial real estate attorneys, brokers, appraisers and property managers.
7. Utilize leverage responsibly: More leverage means higher returns but also greater risk – be conservative initially.
8. Create reserves: Set aside funds to cover vacancies, tenant improvements, and capital expenditures.

Evaluating a Commercial Real Estate Deal

Analyze these key aspects when evaluating a potential commercial real estate investment opportunity:

Property Condition

• Assess structural soundness, mechanical systems, roof, facade etc.
• Review maintenance records and upcoming capital needs.
• Estimate near term and future renovation costs.

Occupancy Rates

• Property should have occupancy over 85-90% in most markets.
• Review current tenants and lease expiration dates.
• Analyze market demand and realistic vacancy rates going forward.

Rental Rates

• Compare asking rents to average rates in local market.
• Verify rents account for vacancies, TIs, downtime between tenants.
• Ensure rents exceed carrying costs and generate positive returns.

Operational Costs

• Review all operating and maintenance costs.
• Include property taxes, insurance, utilities, vendor fees.
• Factor in management fees, reserves, and cost contingencies.

Property Valuation

• Use commercial real estate valuation metrics like cap rate and net operating income.
• Verify purchase price aligns with projected returns and area comparables.
• Conservative underwriting prevents overpaying.

Thoroughly vetting these key items provides the foundation for a sound commercial real estate investment.

Financing Commercial Real Estate Investments

Commercial real estate loans offer more favorable terms than residential loans, but still require good credit, capital, and experience. Popular CRE financing options include:

• Conventional Loans – Similar to residential mortgages but on a larger scale. Require 20-30% down and strong financials.
• SBA 504 – Government guaranteed loan covering 50% of purchase price and improvement costs.
• Portfolio Loans – Offered by community banks and credit unions. More flexibility than conventional loans.
• Bridge Loans – Short term loans (6-24 months) to purchase and renovate before getting permanent financing.
• Hard Money Loans – Asset-based lending from private lenders at higher rates for quicker financing.
• Crowdfunding – Pool money from multiple investors online to fund commercial real estate loans.
• Partners – Join forces with real estate partners who can co-invest to expand purchasing power.

To Recap

Investing in commercial real estate provides the opportunity to diversify your portfolio, generate higher returns, and build long term wealth. It does require more upfront capital, specialized financing knowledge, and hands-on management experience compared to residential properties. By starting small, leveraging experienced partners, and following proven best practices, beginner investors can successfully tap into the lucrative commercial real estate asset class.

The key is approaching commercial investments methodically – thoroughly learning the fundamentals, analyzing deals rigorously, building a strong team, and managing properties closely. While complex, investing in commercial real estate as a novice is certainly achievable with proper education, preparation, and execution. Use this guide to begin your commercial real estate journey and grow your wealth through smart commercial property investments.

FAQs About Commercial Real Estate Investing

What is a good cap rate for commercial real estate?

A good cap rate depends on the property type and location, but generally between 6-10% is considered solid for commercial real estate investments in most markets currently.

How much cash do you need to invest in commercial real estate?

At a minimum, you need enough for a 10-25% down payment plus closing costs and reserves. Many lenders want to see liquid capital reserves even with financing. Starting small with $50k-100k is recommended.

Is commercial real estate riskier than residential?

Commercial real estate entails different risks than residential but isn’t necessarily riskier overall. Lower vacancies, greater diversification, and larger tenants can actually reduce risks in some ways.

What is the best commercial real estate to invest in?

Multifamily, industrial, and medical office are generally among the best performing currently. Research your local market to identify properties with strong tenant demand that provide stable cash flow.

What is the #1 mistake commercial real estate investors make?

Paying too much is the most common mistake – overestimating rents or underestimating costs and overpaying for a property that will not generate the expected returns.

In another related article, The Risks of Real Estate Investing and How to Avoid Them