What Is Commercial Real Estate? 

Before buying a commercial investment property, it’s important to understand the differences between commercial and residential real estate. 

Residential real estate includes only single-family homes and properties with up to four residential units, purchased or leased exclusively by families or individuals. Conversely, commercial real estate is specifically used for generating profit, including residential properties with five or more units. 

Commercial property includes five main category types:

1. Office – This type of commercial property includes low-, mid-, or high-rise buildings used by multiple tenants for professional office buildings. 
2. Industrial – This type of commercial property includes low-, mid-, or high-rise buildings used by manufacturing or operations businesses. 
3. Retail – This type of commercial property is used for businesses selling goods or services to customers and is typically located in accessible urban and suburban areas. 
4. Hospitality – This type of commercial property includes hotels, motels, short-term rentals, and other travel-related establishments.
5. Multifamily – This type of commercial property includes residential properties with more than one unit, including duplexes, apartment buildings, and retirement facilities. 

Once you have properly identified the category the commercial property falls under, you can further classify the commercial real estate by class:

• Class A – This commercial property class grading is typically reserved for new, high-quality buildings in prime locations. 
• Class B – This commercial property class grading is used for high-quality buildings that are not priced as high as Class A properties due to location, material quality, or age.
• Class C – This commercial property class grading is generally given to older properties requiring repairs that are situated in less desirable locations.

Why Should You Invest in a Commercial Investment Property? 

Buying commercial real estate property can be an opportunity to get a sizable return on your investment, but that’s not the only reason investors choose to purchase commercial property. Tax advantages, refinancing opportunities, and hedging against inflation are unique attributes of investing in commercial real estate. Let’s walk through the ways you could benefit from buying a commercial investment property. 

Passive Income

A benefit of buying a commercial investment property is the passive income you’ll receive from leasing the property. Your investment cost for buying a commercial property is higher; nevertheless, you can count on your commercial property to bring in a certain amount of income every month. 

Asset Appreciation

Market analysis reveals that commercial real estate historically exceeds or equals the return of other investment opportunities, including the S&P 500. While buying commercial real estate is a riskier investment, it is a tangible asset that historically appreciates over time. 

Increased Equity

Buying and holding on to commercial real estate property can help you build equity more quickly than other investments. As the building appreciates, you can see a steady increase in your cash flow. 

Reduce Effects of Inflation

With inflation rising in the U.S., buying commercial investment properties becomes an even more favorable opportunity for investors. According to a recent report published by BlackRock, real estate has historically outperformed other asset classes during periods of inflation. 

Tax Benefits

Buying a commercial property comes with several tax benefits that make the investment even more worthwhile. While it’s important to speak with your tax professional to understand the full tax benefits of buying commercial property, you can count on mortgage interest and depreciation deduction on your tax bill when investing in commercial real estate.

How to Buy Commercial Real Estate 

The strategy behind buying commercial real estate is similar to purchasing traditional residential real estate. From ensuring you use the right strategy to running the numbers and finding the right lender, buying commercial real estate is the same as traditional real estate, just on a bigger scale. 

As you begin your research, keep these important steps in mind:

Decide on an Investment Strategy

The first step in buying a commercial investment property is determining which strategy to use to acquire the investment. Here are a few strategies you may be interested in researching further:

BRRRR

This investing method is used in buying residential real estate properties and commercial real estate properties. Buy, rehab, rent, refinance, and repeat is a common strategy for purchasing real estate properties of all types, and it’s likely the most familiar strategy. 

Passive Investing

Many investors are familiar with and interested in the passive investing method. This strategy is used by investors looking to buy commercial real estate properties solely for passive income. It is a great investing strategy when you don’t have the bandwidth to take on lengthy negotiations or maintenance. 

Commercial Flip

Similar to traditional residential flips, this strategy is a good fit for those willing to buy a commercial property that needs some work. With repairs and upgrades, many investors take the opportunity to resell at a higher cost than what they purchased the property for, making a significant return on investment. 

Land Banking

Land banking is an excellent strategy if you’re interested in long-term appreciation. Investors use this strategy to purchase large tracts of land that are slated for future development. Though you don’t get the return as quickly, there can be significant returns on investment as the land appreciates in value. 

Development

Similar to land banking, the development strategy is for investors looking to purchase land slated for future housing construction. 

Wholesaling

This strategy is perfect for the investor looking to make a return on investment without holding on to a commercial property long-term. After finding a suitable commercial property, investors will put the property under contract but then sell it to another investor. 

Assessing a Commercial Property’s Value 

Once you’ve determined the strategy you’ll use to buy a commercial investment property, the next step is to consider your financing options. Assessing commercial property before purchasing is an important step in securing financing. 

Use the following formulas to estimate a commercial investment property’s value:

• Cost Approach Appraisal: cost of the land plus cost of construction less depreciation
• Sales Comparison Approach: research recently sold properties of comparable size and attributes.
• Gross Rent Multiplier (GRM) Approach: determine the rent you can make from the property each year. 
• Income Approach: determine the annual capitalization rate of the property by taking the projected annual income from the GRM divided by the property’s current value.

If you need help conducting a comprehensive market analysis to determine the financing approach that is right for you, don’t hesitate to reach out to us. Our team of experts will help you make an informed decision about buying a commercial investment property.

Find a Lender 

In addition to determining a commercial property’s value, you’ll want to begin your search for the right financing method. Securing financing before searching for a commercial investment property is a way to ensure the deal runs smoothly and closes quickly. 

There are several financing methods you can use, including conventional loans, private money lenders, hard money lenders, home equity loans, and seller financing strategies. Because interest rates vary from lender to lender, it’s important to know your numbers. 

Understanding the commercial property’s loan-to-value ratio and your financials before seeking a lender will help you immeasurably. Lenders will assess the loan-to-value (LTV) ratio before approving any financing. Usually, lower LTVs are seen as less risky by lenders, but you are more likely to have to put down a larger down payment to secure the loan. 

To find your LTV ratio, divide the amount you’re seeking to borrow by the appraised value of the commercial property. Combining this number with your credit score provides a solid foundation for estimating the right loan type and lender for buying a commercial investment property.