A Guide to Investing in Commercial Property

Investing in commercial property can be a great way to build wealth and acquire a steady source of passive income. But for many people, commercial property is an intimidating type of investment to get involved with. And we get it – commercial real estate investing can appear complex. Today, we’re going to break this investment strategy down and provide helpful tips and tricks for getting started.

Types of commercial properties

Commercial properties typically fall into three main categories: office, industrial, and retail:

Office - As you may have guessed, office property refers to real estate leased by professional service firms, administrative users, and other ‘white collar’ tenants. This includes highrise towers and skyscrapers in city settings to mid-rises and office parks in suburban areas. Office properties come in a wide range of sizes and styles offering investors many options to choose from depending on their investment goals. Office building leases often are firm commitments in the 5-year to 15-year range.
Industrial - Industrial properties refer to real estate that’s used for e-commerce distribution, manufacturing, and other ‘blue-collar’ business operations. Most often, this includes buildings such as warehouses, distribution centers, product assembly factories, etc. Historically, industrial properties are located in outlying but logistically key areas that would be seen as undesirable for retail or residential properties. Leases for industrial properties typically last for 5-years to 20-years.
Retail - Retail properties refer to spaces that are used by retail businesses to conduct business directly with the public. This could include clothing shops, restaurants, storefronts, strip malls, shopping malls, factory outlets, etc. Leases for retail properties tend to fall in the 3-10 year range.

How investing in commercial property generates returns

Your commercial real estate investment strategy will start with the acquisition of a property that either has an existing, rent-paying tenant in place already or a vacant property that is (or can be made) desirable to that market’s tenant-base. Through this purchase, you’ll generate a return on your investment in three ways: 1) by leasing the property and collecting rent from a tenant(s), 2) by taking advantage of property tax benefits (depreciation and interest payments write-offs), and 3) appreciation of the asset over time while the property is owned. Here’s a little more on how commercial real estate investing can generate returns.

Rental income

Investing in CRE is a great way to acquire a steady stream of income due to the longer lease terms associated with commercial tenants, which often provide a corporate guaranty of lease payments. On average, commercial properties yield a 6-12% return on investment according to Fortune Builders.

Tax benefits

The second - Depreciation: IRS acknowledges that for rental properties, natural wear and tear is a tangible factor that impacts the overall value of the property. Depreciation is a tax benefit that allows commercial real estate owners to recover the cost of maintaining their income-producing properties but always consult with your accountant who focuses on real estate tax laws.

In addition, property mortgage interest deduction provides excellent tax benefits. This deduction helps investors own property while it appreciates and enjoy a positive cash flow with lower tax liability.

Appreciation and value-add

The third—but equally as important—way to gain returns on your investment is through the increase in the property’s value, or appreciation, throughout your period of ownership. For an investor that has a larger appetite for risk, value-add properties can generate very strong yields. To identify potential targets, you’ll want to look for buildings that:

Have higher vacancy;
Need cosmetic renovations;
Have deferred maintenance issues;
Have functional obsolescence;
Or have the opportunity for significant exterior or landscaping improvement;
Commercial real estate investment strategies

At its core, commercial real estate investment is about acquiring an existing or potential, durable income stream while also identifying demand for a particular product type (e.g. office, industrial, retail) or particular tenancy (e.g. ‘essential’ business) in a given submarket/city and purchasing property while supply is limited. Checking all of these boxes can be complicated. To ensure you get the best return on your investment, based upon your unique risk vs reward tolerance, you need a sound investing strategy. Some examples of common commercial real estate investment strategies include:

Lowest risk – STNL Cash-Flow MOB: Identify a medical office building fully-leased to a single national credit-rated tenant (with corporate guaranty) that is committed on a longer-term NNN lease of 10+ years in a larger urban area.
Lower-to-moderate risk – Multi-Tenant Light Industrial; Target a light industrial/flex (part office & part warehouse) that is 85%+ leased to local and regional-credit tenants with existing lease terms of 2-5 years remaining in proven submarkets.
Moderate risk – Office Building for Renovation: If you identify an office in an established suburban submarket with older common area finishes, outdated suite features, smaller suite sizes, and moderate vacancy, purchase the building and renovate the vacant suites & common area finishes so you can increase rental rates and achieve overall appreciation after fully stabilized.
Higher risk – Industrial Property for Redevelopment: Identify a distressed submarket that has opportunity for economic resurgence over the next few years. Then purchase an industrial property with a shorter-term commercial tenant in place. In the long term, plan to have the property up-zoned and redeveloped into retail, office, or mixed-use real estate as the neighborhood begins booming.
Highest risk – Land for Entitlement then Develop: Target a land parcel that has virtually no development but is ripe for population and economic growth in the coming years. Then acquire the properly-zoned land, obtain the necessary permits, and develop the land after forming joint venture with a proven contractor.

Learn more about investing in commercial property with Fountainhead Commercial

If you’re interested in learning more about investing in commercial property, reach out to us at Fountainhead Commercial. We are your one-stop-shop for all of your commercial real estate needs. We take pride in ensuring every client we work with is buying, selling, or exchanging their real estate at the right time, to the right entity, and at the right price.