The commercial side of real estate can be an appealing proposition for any investor. It offers you the ability to dip into a new pool of clients and grow your business interests. It’s no surprise, then, that interest in commercial property investment has been escalating. However, commercial real estate investing is quite different to the residential side of the business. Knowing when to invest in commercial real estate, what to invest in, and how to invest is critical to success or failure. It’s also crucial to know the common pitfalls, mistakes, and risks of commercial real estate investment, so you can prepare for them. Here are some important considerations when investing in commercial real estate that investors should be aware of before getting involved with commercial property.
Considerations when investing in commercial real estate
Not all property types are the same
Commercial real estate has a wide variety of asset types. While commercial real estate is typically classified into five main sectors; industrial, office, retail, multifamily, and special purpose, there are many other property types such as self-storage, medical, elder care, land, or hotel. The supply and demand, yield, and overall profitability of each sector vary greatly. Some property types perform better than others based on the supply and demand in the asset’s specific location. Therefore, it’s crucial to know how to identify the asset types that are most profitable or offer the biggest opportunity.
Understand market area and supply and demand
One of the most crucial things to know when investing in commercial real estate is that each market is unique. When you invest, you’re investing in a specific geographic area with its own supply and demand dynamics. With this in mind, undertake adequate market research to determine if there is a potential risk of market saturation. If you have identified a property type that is undersupplied in your specific market, you can get a feasibility study. This will help you outline the future growth and likelihood of success in that sector.
Understand market cycles
The profitability of commercial real estate is directly related to the economy’s health, unemployment rate, and GDP. Understanding how real estate market cycles work can help you avoid buying when the market is high and being forced to sell when the market is low. Additionally, knowing specific indicators of the various market cycles will help to determine what opportunities are present right now and make more informed investment decisions.
Have a backup plan
Any investment entails some level of risk. There will always be unknown aspects, no matter how much investigation, verification, or preparation you do. These factors can have a favourable or negative impact on your overall yield. Accounting for cost contingencies is one strategy to mitigate this risk. Cost contingencies are additional funds you set aside as a part of your initial acquisition costs to help with unexpected expenses. They can also be used to help cover your debt service until the property is stabilised.
Be prepared for setbacks
Just as there are uncertainties with costs, there are also uncertainties with the timeline. Most people set unrealistic timelines in which to build, renovate, fully lease, or reach market rents for their investment. There will almost always be setbacks and challenges that stall progress. Try to identify the potential obstacles in your due diligence period and prepare for them as a part of your contingency costs.