Statista reports that commercial real estate development in the United States has been steadily increasing since 2010. Meanwhile, these properties’ vacancy rates have been decreasing. It indicates an ongoing demand for commercial property and that new space is being absorbed as it is constructed.
The only way to invest was to buy real estate directly or through closed private groups. Thanks to the Internet, anyone can now invest in commercial real estate online. Making a passive investment in real estate online has several advantages over traditional methods, the most important of which is that you don’t have to deal with tenants or perform many duties that a landlord must perform.
Reasons to Invest in Commercial Real Estate
When buying commercial property, most people think of multifamily apartment buildings or office space. The two most common commercial property types of investing are not the only ones. The commercial real estate industry is much broader than that. Retail centers, warehouses, industrial properties, “mixed-use” buildings, hotels, land deals, and other commercial property types are also included.
One of the reasons commercial real estate appeals to so many investors is its broad nature.
Few reasons why commercial real estate is appealing to investors:
- There is little correlation with the broader equity markets. In other words, the stock market may fall, but commercial properties may retain their value. It makes commercial real estate an excellent way for investors to diversify their portfolios while attempting to mitigate risk and incorporate a measure of stability during periods of volatility.
- Commercial real estate has the potential for both income and appreciation. There are a variety of deals available for those looking to generate short-term cash flow that produces 5-15 percent (or more) annual returns—typically in the form of cash flow distributions. Those with a longer time horizon usually benefit from the property’s appreciation over time.
- Commercial real estate can be a hands-off business. Most people prefer to invest as limited partners in syndication or a fund. The project sponsor, usually an experienced commercial real estate professional, is responsible for day-to-day property management. It allows investors to “set it and forget it,” provided they have done their due diligence on the sponsor and the deal ahead of time.
So, if you have money and want to invest in commercial real estate, how can you do so without purchasing a physical property? Here are the following suggestions to get you started:
1. ETFs that invest in commercial real estate
ETF is an abbreviation for exchange-traded funds. In a nutshell, this fund combines several stocks or bonds (or a combination of the two). ETFs are similar to index and mutual funds in two ways. They are low-cost investment vehicles due to their broad diversification of stocks and bonds.
What Exactly Are Investment Vehicles?
An investment vehicle is any mechanism that allows a person to invest in a product that produces a positive return. The expected investment vehicles are stocks, bonds, options, and futures. However, there are other investment vehicles, such as commercial real estate, ETFs (exchange-traded funds), and REITs (real estate investment trusts), which we discuss in greater detail below.
Investing in a commercial real estate ETF can be an excellent way to put your money to work for you. For example, investing in new commercial construction projects is a highly liquid way. When you invest your money, you are not investing in specific projects. You are instead investing in the stock of real estate companies and real estate investment trusts (REITs).
2. Mutual funds for commercial real estate
Another intriguing way to invest is through commercial property real estate mutual funds. Once again, they are highly liquid and frequently have low management costs. Some mutual funds, such as the DFA Real Estate Securities Portfolio (DFREX), claim to deliver consistent returns by adhering to a strategy supported by decades of academic research.
Remember that some real estate mutual funds mix residential and commercial investments. The good news is that some only invest in commercial real estate. It’s worth investigating which holdings are focused on commercial real estate and top-performing mutual funds whose portfolios include such.
Commercial vs. Residential Investments
There are some significant distinctions between residential and commercial real estate investments. Residential properties, ranging from two-family rental properties to apartment buildings with 200+ units, require more management than commercial properties. Leases are typically signed annually and then converted monthly, resulting in a frequent turnover. In a 200-unit building, this could mean that an owner deals with calls from 200 or more people weekly. Most investors understand the fundamentals of residential leasing properties and are thus drawn to the simplicity of residential investing.
Commercial real estate is a little trickier. Leases are more nuanced and often tailored to the tenant’s specific needs and circumstances. Leases, on the other hand, are typically longer (5-10 years) and structured as “triple net,” which means that the tenant pays their pro rata share of taxes, insurance, and standard area maintenance (CAM) charges. It reduces the owner’s financial burden. Those who understand the nuances of commercial real estate find this market segment highly profitable and thus drawn to commercial property mutual funds.
3. Reits for Commercial Real Estate
REITs (real estate investment trusts) function similarly to mutual funds. The only difference here is that you can diversify your holdings based on the real estate class the REIT invested. When you invest in a REIT, you have far more say over where your money is invested.
REITs are another popular way to invest in commercial real estate without being a landlord. When you conduct market research, you will come across many commercial property REITs that best meet your requirements. Avoid non-publicly traded REITs because they frequently lack liquidity, high costs, and low transparency.
How to Choose the Best Commercial Property REIT
REITs frequently specialize in a specific product type (for example, multifamily, office, retail, or hospitality) or geography (e.g., Northeast, Southwest). Some prefer to buy and hold for the long term, while others prefer to invest for the short term. Investors must assess the REIT’s business strategy to ensure it is consistent with their goals and priorities.
When selecting the best commercial, these factors to consider real estate investment trust are:
- Management: Examine the management experience and track record of the REIT. Examine how the REIT has performed over multiple real estate cycles. Be wary of those who have recently emerged and have only been active during the most recent market upswing. The performance of a REIT during previous downturns is instructive.
- Diversification: Diversification of REITs is viewed differently by different investors. Some may argue that the REIT’s lack of diversification (i.e., specialization) is advantageous because it allows it to concentrate on what it does best. Others, on the other hand, advise investing in a REIT with greater diversification across product types or geographies. It protects against risk.
- Dividend Yield: Examine how a REIT has performed over time like you would a stock. Examine the REIT’s current dividend yield as well as its dividend history. How quickly have dividends grown over time? Consider how this compares to other investment options.
4. Shares of a Commercial Real Estate Company
You may be unaware that companies specialize in buying and managing commercial properties and accept individual investors in their projects. Depending on your needs, it may make more sense to invest in one or more of these companies individually rather than through the pooled money structures of a mutual fund or REIT.
The companies in question frequently concentrate on assets such as apartments, office buildings, senior housing projects, student housing, etc. As you can imagine, such investments can have some drawbacks. The most significant is that, while the return on investment is among the highest in the industry, the risk is proportionately increased.
Because there are few formalized ratings for these investments, you’ll need to examine the company’s offering before purchasing any shares thoroughly. You have more investment diversification options than ETFs, mutual funds, and REITs.
5. Shares of a commercial property construction company
Do you want to put your money solely into new construction projects? If so, investing in commercial construction companies could be the way to go. As previously stated, commercial construction has been steadily increasing since 2010. As a result, opportunities to invest in large-scale commercial construction projects exist.
You can do so by purchasing stock from the companies carrying out those projects. New commercial properties will always be in demand, whether retail units or office blocks in expanding central business districts of major cities.
6. Making a Loan to a Real Estate Investor
On a smaller scale, you may come across opportunities that are likely to provide a relatively high ROI.
Using such websites makes borrowing easier for real estate investors while costing them less due to lower fees. However, the disadvantage is that peer-to-peer lending is inherently risky. Furthermore, some lenders only permit a low LTV (loan-to-value) ratio, such as 65 percent.
Peer-to-Peer Lending for Commercial Investments: Risks and Rewards
As previously stated, investing through peer-to-peer lending has both advantages and disadvantages.
Let’s begin with the benefits.
Some of the benefits of peer-to-peer lending include:
- High-interest rates: Because many investors use P2P lending as a last resort, investors can usually charge a higher premium for their loan than they could through other real estate investing opportunities.
- Short-term in nature: Many P2P loans are of the short-term variety. Loans of one year or less are possible, especially if the owner only requires bridge capital, construction financing, or other short-term capital. The majority of borrowers will then use more traditional lending products to recapitalize. It allows investors to keep liquidity if they need access to that capital in the near or medium term.
Risks associated with peer-to-peer lending include:
- Higher risk of default: When all other traditional sources of capital have run dry, many P2P borrowers turn to this source of money as a last resort. It could indicate a problem with the project, such as cost overruns. Depending on the transaction, the investor (P2P lender) could be in the second, third, or even fourth position for repayment, putting their capital at risk compared to the senior lenders in the posts ahead of them. If the borrower fails to repay, the P2P lender may be the last to be paid (if at all).
- Online P2P platforms are still new: While peer-to-peer lending has been around for decades (offline), those who participate in online real estate investing place a lot of trust in the underlying platform used to structure the transaction.
Do you know a commercial real estate investor with a knack for spotting the next big thing? You could also consider lending them some money if that’s the case. It’s a win-win situation, and you have more direct involvement in the investment.
7. Crowdfunding for Commercial Real Estate
Last but not least, you might think about investing in commercial property crowdfunding projects. It’s a relatively new way for retail real estate investors to raise capital for their projects.
You will also have the opportunity to choose which commercial property investment verticals interest you. One platform specializes in commercial real estate in major U.S. cities, while another one offers access to industrial and multi-focus offerings, and a third accepts non-accredited investors. You have lots to choose from!
These crowdfunding investment websites allow you to manage your investments through a simple online portal. Many growing commercial real estate investment firms use crowdfunding for marketing their brand to potential investors. Crowdfunding is a relatively new concept, having existed for a few years. While commercial property crowdfunding is unique, the science behind it is not.
The Advantages of Investing in Commercial Property
A few distinct advantages to investing in commercial real estate. These are some examples:
- A consistent source of income. People like investing in commercial real estate because of the constant cash flow that properties generate. Investors frequently receive cash distributions on a monthly or quarterly basis.
- Real estate is highly tax-favored. Commercial property will frequently generate a “loss” on paper while producing double-digit returns for investors due to write-offs such as depreciation. It makes commercial real estate investing appealing to those looking to maximize their taxable income.
- The ability to leverage Investors to gain equity in the property as tenants pay down the mortgage and make improvements to the building. This equity uses to invest in other commercial real estate transactions, assisting investors in building their portfolios over time.
- There is very little correlation with the stock market. As previously stated, commercial real estate has little correlation with broader equity markets. It means that fluctuations in the stock and bond markets have no significant impact on retail real estate values. Commercial real estate values move slowly and frequently lag behind any broader economic disruption. In other words, while other investments are volatile, commercial real estate can (and often does) maintain its value.
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