What Is Commercial Real Estate: Know In Depth

Real estate offers tax breaks, cash flow, equity building, competitive risk-adjusted returns etc, and a hedge against inflation. It also enhances a portfolio by lowering volatility through diversification, whether you invest in physical properties or REITs( real estate investment trusts ). If you are one of those who want to take benefits from real estate, then you are at the right place. But first, you have to know more about “what is commercial real estate.”

Precap: 

What is commercial real estate?

Various properties which come under commercial real estate

How Investors Make Money from Commercial Real Estate?

Benefits of commercial real estate

How Can You Invest in Commercial Real Estate?

Quiz

What Is Commercial Real Estate?

Commercial property is also called commercial real estate. It is buildings and land that generate income, and while the definition varies among separate countries, the core offering remains the same.

It comes in a variety of forms. It can be anything from an office building to a residential duplex, a restaurant, or a warehouse. Individuals, companies, and corporate institutions can make money from commercial real estate by leasing it, holding it, and reselling it.

Commercial real estate includes several categories, like retailers of all types: office space, hotels, and resorts, strip malls, restaurants, healthcare facilities, etc.

Commercial real estate is divided into four categories, depending on function:

• Office space
• Industrial use
• Multifamily rental
• Retail

Office space:

Office property, as the title suggests, comprises land that is utilized to construct office buildings. This includes office parks and mid-rise buildings in suburban locations, as well as skyscrapers and high rises in urban areas.

Industrial use:

It is used for industrial business operations. This can include heavy manufacturing, assembly, warehouses, research, and development buildings. Oil refineries (heavy manufacturing), Amazon distribution centers (warehouses), product assembly factories, and pharmaceutical research and development facilities fall into this category. 

Multifamily rental:

Multifamily properties offer residential homes in exchange for rental payments. Buildings with more than three and four units are generally considered multifamily properties. The size and number of these units’ properties can vary broadly. Multifamily rental lease agreements are usually more flexible in terms of duration. Residential leases can be short and long-term but typically not longer than a year. 

Retail:

This type of commercial real estate includes properties that provide the spaces required for retail businesses to conduct business with the public. Restaurants and clothing shops are considered retail real estate. This type of commercial real estate can be developed in large multi-tenant complexes in shopping malls, strip malls, factory outlets, and other shopping centers.

also read: Learn Fundamentals Of Finance To Become Pro

Various Properties Which Come Under Commercial Real Estate

• Retail Stores
• Offices
• Hotels
• Warehouses
• Apartments
• Rental Property Upgrades
• Commercial Development

How Investors Make Money from Commercial Real Estate

As above, you read what is commercial real estate and its types. Let’s talk about how investors make money from Commercial Real Estate. There are two investments, investors and you can make money.

• Direct investment
• Indirect investment

Direct investment:

Investors can use direct investment when they become a landlord (owner) of a physical property. This investment is best suited for those who either have a considerable amount of knowledge about the industry or can employ firms that do because commercial properties are high-risk, high-reward real estate investments.

Indirect investment:

Through ownership of various market securities, like real estate investment trusts or exchange-traded funds that invest in stocks related to commercial real estate, or through investments in businesses that serve the commercial real estate market, like banks and realtors, investors can indirectly invest in the commercial market.

Benefits Of Commercial Real Estate

Cash Flow and Current Income

Commercial real estate investments potentially offer regular income that can be more than typical yields on dividend stocks/bonds. Stable income can provide protection and diversification against the volatility of the financial markets, and commercial real estate historically does not move in sync with stocks/bonds.

Tax Benefits

Commercial real estate investments like the ones offered on RealtyMogul.com’s platform can provide an array of tax benefits to a real estate investor.

Deductions related to depreciation, interest expense, and other items can potentially shelter and defer taxes on cash distributions.

For example, Current cash flow will often be less than the total depreciation and interest expense creating a return similar to a tax-free bond. In most cases, these benefits will be recaptured upon the sale of the property.

Depreciation recapture is taxed at 25%, while the remaining profit or capital gains is taxed at the long-term capital gain rate.

 

Inflation Hedge

Direct investing in commercial real estate can be a great hedge against inflation for investors concerned about how it will influence their portfolios.

Inflation is likely to be tolerated by investors in commercial real estate, given the asset class’s historical performance, according to a TIAA-CREF analysis. Historically, returns on commercial real estate have done well to beat inflation over five-year holding periods. Commercial real estate returns have shown a slight correlation with inflation over short periods, suggesting their capacity for “inflation hedging.”

Leverage

The main benefit of direct commercial real estate investment is the ability to place debt on the property, increasing the purchasing power of each dollar of equity. This, in turn, increases the total returns of the property. It also increases the risk.

For example, a $1,000,000 property. Typically, only $250,000 of equity will be required, with the balance funded by debt.

If the property is then sold for $1,250,000 in a year, the cash return would be 100%. If the property were purchased with no debt, the cash return would only be 25%.

Higher Income

Commercial properties have a higher return on investment, an average of 6 to 12 percent, while single-family properties fetch between 1 and 4 percent. Commercial real estate also provides a lower vacancy risk, as properties tend to have more available units.

Less Competition

Another benefit associated with commercial real estate is relatively less competition. Commercial investing is thought to be more challenging than other types of investing; hence there are less other investors in this market.

I hope till now you understand what is commercial real estate, the types of commercial real estate, and properties. We also discuss some benefits. If you are interested in commercial real estate, then know how to invest in commercial real estate.

How Can You Invest In Commercial Real Estate?

Understand How Commercial Real Estate Is Different

Firstly as a commercial investor, you have to understand that commercial real estate is valued differently from residential properties.

Analyze Comparables

The second step is to analyze comparables in the area and research future developments. Analyzing comps will help you determine the present market value of a property.

Use The Right Success Metric

Commercial real estate investing adds a wide array of calculations and an understanding of real estate finance. To be a good investor in commercial real estate, there are some formulas you should know.

1)Net Operating Income, 

2)Cap Rate, 

3)Cash On Cash

Reserve Cost Contingencies

Cost contingencies are essentially rainy-day funds that are set aside to cover unexpected acquisition expenses.

Commercial Real Estate Investing Mistakes To Avoid

Below are some points about the most common mistakes commercial real estate investors need to avoid:

1)Improper Valuations

2)Financial Ignorance

3)Neglecting Due Diligence

4)Not Working With a Team

Quiz: What Is Commercial Real Estate

Que1.All of the following EXCEPT, which are risks to owning commercial real estate?

1. Increased Levels of Insurance
2. Low Vacancy Rates
3. Expensive Repairs
4. High Professional Expenses

Que2. Which is NOT a common approach to commercial real estate valuation?

1. Income Approach
2. Gross Rent Multiplier
3. Sales Comp
4. Comparative Market Analysis

Que3. Which method is a way to hedge inflation with commercial real estate?

1. Collect rent in foreign currencies and convert it into US dollars
2. Borrow against your equity in the property
3. Buy and Hold
4. Inflation-based rent increases in lease

Que4. Which is the correct math to determine Cap Rate?

1. Rental Income minus Expenses
2. Net Annual Rental Income divided by Current Value
3. Cash flow after debt service
4. Sales Price divided by Annual Gross Rent

Que5. What is the real interest rate when the nominal interest rate on a bank checking account is 1%, and the inflation rate is 2%?

1. 3%
2. -1%
3. ½%
4. 1%

Conclusion 

What is commercial real estate?In simple ways, commercial real estate is a property that can generate profit through capital gain and rental income. Commercial property can be anything from an office building to a residential duplex, a restaurant, and a warehouse.

FAQs: What is commercial real estate