So you want to invest in some commercial real estate—maybe even in value-add real estate. This is an exciting decision, but it requires quite a bit of research before you start out.
Investing in commercial real estate is a different ball game than buying residential real estate. You aren’t making a purchase for yourself. In fact, you might not be making the purchase at all.
Investors have many options for playing the real estate game, but if you don’t know what you are doing before you buy, you might lose out to unexpected expenses.
Why invest in commercial real estate?
Real estate is a fantastic investment for investors who may want to diversify their portfolio or put money in a growing market. Investors who already have publicly traded equities (stocks) or bonds can spread their investments—because no one wants to put all their eggs in one basket. Plus, it can be exciting to see your investment play out “in real time” as cities and hot areas grow and buildings start to pop up.
How to Invest in Commercial Real Estate
Whether you want to be the next HGTV star or just want to make some passive income, consider the different ways you can buy into the real estate game:
- Buy into a real estate investment trust (REIT)
- Connect with a developer through an online real estate platform
- Purchase a rental property and become a beloved landlord
- Play “Fixer Upper” and resell renovated properties
- Put your spare rooms on Airbnb or other rental platforms
You probably have an idea of which option is best for your current financial situation and needs. Let’s dive into the first option.
Real estate funds use a variety of investment strategies to build, manage, or flip properties. Before you invest, know what the operators of the REIT are up to and what risks they are taking in the real estate market.
Investment properties tend to work like most money-making opportunities: the more you put into the work, the more you get out. Know what real estate sectors you are putting your money toward before you invest.
Different Types of Real Estate Investments
Commercial real estate investments are divided into three or four categories: Core (and core-plus,) Value-Add, and Opportunistic. Investors and financers categorize these types of investments based on the amount of risk involved vs. the potential return.
Core properties offer little risk but a low potential for astronomical returns. Examples of core investments include fully leased office buildings or recently renovated apartments in hot markets.
Opportunistic properties come with high risk but offer the potential of high returns. Examples of opportunistic investment properties include abandoned warehouses or even raw land that has the potential to become a decent spot for commercial real estate in the future.
Value-Add Real Estate
Value-add real estate is the Mama Bear of real estate investments. These properties come with some risks but have the potential to bring modest to high returns – for many, these are just right.
What Is Value-Add Real Estate?
The purpose behind value-add real estate lies in the name. Investors buy these types of commercial properties in order to add value and gain a profit from their efforts. Once they have added a favorable amount of value, they can cash in and use the increased equity to move onto the next project.
Again, these properties come with some risks, but not as much as an opportunistic property that needs a complete rehab. The property may not do a complete 180, but it still holds the potential to bring the investor decent returns.
Why now is the best time to invest in value-add real estate
America is finally out of the Great Recession and things are looking up. During the Recession, it was easy for investors to get their hands on property that was subject to foreclosure. Everything was snatched up. Now that these properties have been acquired, it’s time to add value and refine the properties that were purchased during the Great Recession.
Value-add properties also offer a middle ground. Investors face risks when they buy value-add real estate in the wrong markets. They reap great rewards when they know what they can do to appreciate the value of the property. With the right knowledge of the real estate market in your area, you won’t be gambling by investing in value-add real estate.
Ways to Add Value to a Value-Add Property
- Complete renovation projects and small physical improvements that will increase curb appeal or attract high-quality tenants
- Implement management changes to improve service or attract high-quality tenants
- Cut costs through various strategies or investment purchases
- Raise rent costs to match current prices on the market
The right investment strategies will depend on the type of investment that you purchase, how long you plan to hold onto the investment property, and where the property is located.
Value-add properties do well in secondary markets that are currently booming if investors don’t plan on holding the property long term. Experienced investors seek out value-add property that does not require too many improvements, so it can be “flipped” and sold before the market slows down again.
What To Consider Before Investing in Commercial Real Estate
Value-add properties are certainly the talk of real estate investors and real estate funds. Before you put your money toward adding value to any property, consider the following factors:
Consider the current real estate market where you are investing and where it may be once renovations or building is completed. Is the area experiencing growth? How long is that growth projected to last? Will tenants find value in your property once it is ready compared to properties in the area?
What exactly does the operator want to do with their properties? Do they want to renovate the property or simply charge higher rents? What is the purpose of the properties that they own (hospitals, hospitalities, office space, etc.)? What is the proposed hold period, and what do investors plan on getting done during that time?
Diversity of Properties
If you are investing in a REIT, consider the types of investment projects that they hold and how they make their income. Different properties come with different types of expenses (taxes, insurance, regular repairs, etc.) A higher diversity often comes with a low altogether risk.
Remember the old saying: “The best time to invest was yesterday. The next best time is today.” Talk to a financial advisor about the best real estate investment options for you and how you can start investing.