Commercial real estate (CRE) can be a great way to build wealth. By investing in commercial properties, you can create passive income and increase wealth over time. Commercial real estate is a great way to build wealth because you can:
- Leverage long-term passive income
- Choose the commercial property type that works best for you
- Get creative with layering wealth-building strategies
- Keep income flowing while staying hands-off
- Study the risks and know how to avoid them
Ready to dive in and learn how to develop high-yielding assets with non-residential properties? Keep reading to learn about the five ways to build wealth with commercial real estate.
Leverage the Long-Term, High-Volume Income of CRE
Commercial real estate investments are one of the best ways to build wealth. Traditional wealth-building tactics like IRAs and 401(k)s don’t start putting money in your pocket until you’re officially retired. Commercial real estate investments can offer high income right away while still appreciating and contributing to your overall wealth in the long term.
Long-Term Passive Income
No early retirement strategy is complete without a plan for passive income. Passive income from rental properties provides a powerful supplement to a diverse portfolio of equities. Investing in rental properties follows many of the same rules as investing in stocks. As such, diversity is vital.
If residential properties dominate your current rental property portfolio, consider diversifying with commercial real estate investments.
Like residential rentals, commercial properties generate income via monthly rent payments from tenants. One of the most significant differences between commercial and residential real estate is the lease durations. Commercial real estate leases last anywhere from one to ten years, whereas most residential leases span one year on average.
Longer leases keep passive income flowing. Searching for tenants to fill residential properties costs time and money. When rentals sit vacantly, the owner loses money. When marketing and tenant vetting tasks add up, the income stream becomes less passive.
The long leases associated with commercial rentals protect the landlord’s time and money, freeing them to enjoy more of their early retirement.
Higher Down Payments, Higher Earning Potential
Commercial real estate costs more on average than residential properties. But, as the old saying goes, “you have to spend money to make money.” Although commercial real estate costs more upfront, these pricy investments can be cheaper than investing in dozens of residential properties.
Down payments for commercial real estate can range from 15-30{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd} of the total purchase price. Mortgage rates work the same way as the residential sector: the more you pay upfront, the less you pay per month.
Higher down payments are generally required because the risks associated with lending on commercial properties are more severe than with residential properties.
The high value and longer leases of commercial properties make them a more attractive investment to lenders.
The higher up-front investment results in more significant monthly cash flow and higher potential returns. Property per property, commercial real estate offers higher profit margins than residential real estate.
While the down payment requirements for residential and commercial properties vary by location, the average minimum investment for a commercial property is 20{6f482cd57796f86e9ad1be82bcf1dcf19049bb2b279893497447a8f8ed9023fd}.
Higher Rents Yield Greater Income
Not only do commercial leases last longer, but they also command higher rents than their residential counterparts. Commercial rents usually reflect the greater value of the property and the longer-term commitment of the tenant.
In most cases, commercial tenants are businesses rather than private individuals. Businesses are more likely to have a reliable income and less likely to default on a lease agreement.
Commercial properties offer the opportunity for triple-net leases, unique contracts that make the tenant financially responsible for property taxes, insurance, and maintenance. Triple-net leases make it easy to calculate profits since the landlord gets to keep almost everything that’s left.
Optimize Your Commercial Property For The Business You’re Attracting
Businesses are often willing to pay top-dollar to get results. Savvy business owners know that investing in a quality commercial rental increases their chances of success. By optimizing your property’s location and amenities to the type of business occupying your rental, you can raise the amount you can charge for rent. Here are a few ways to increase the appeal of your commercial property.
The most common commercial real estate property types include:
- Multi-Family Residential. A commercial multifamily property is any building with more than five units.
- Offices. This property type is any building used as a business-related workspace, usually without on-site customers.
- Industrial. Manufacturing centers, distribution warehouses, and refineries are all common industrial commercial real estate types.
- Retail. This property type is zoned to conduct daily business with the public. Restaurants and shops are the most common examples.
If a property type doesn’t fall into one of these categories, it’s assigned to the “other.” The “other” category in commercial real estate investments includes medical facilities, storage units, eldercare facilities, and other forms of long-term care. New types of business emerge every year, creating near-infinite possibilities for commercial real estate investments.
Location Matters for Building Wealth With CRE
The best locations for commercial real estate investments vary based on the type of business you’re targeting.
If you’re looking to attract retail companies or restaurants, you might look into trendy, up-and-coming areas with great walkability.
On the other hand, if you’re after industrial business, you’ll need to look for a warehouse-style property in an area that can support heavy machinery, large trucks, and anything else the company might need.
The Best Amenities Attract The Best Tenants
To make your property as appealing as possible, you should provide top-tier amenities. Of course, the type of amenities you offer will vary based on the type of commercial real estate investment you’ve made.
Multi-family commercial real estate investors can explore the same amenities that residential landlords use to increase rental income. Some examples include swimming pools, game rooms, and fitness centers.
Office property owners need to study the latest trends to provide up-to-date amenities. Start by updating all the technology to meet current standards. High-speed WiFi is a must, and outdated appliances like fax machines aren’t the highest priority. Consider the designs that encourage employees to do their best work.
When it comes to industrial property, your amenities will be focused more on the infrastructure than the quality of life. If you’re trying to fill the space with a manufacturing company, make sure that the property has sufficient power and water supply and easy access to raw materials.
Retail companies often need parking, and it’s essential to have a plan for traffic congestion. Restaurants require special modifications like specialty ventilation and other kitchen equipment.
Leverage the Advantages of Forced Appreciation
Forced appreciation is a term used in real estate to describe any event or action that artificially raises the value of a property. Most real estate investments naturally appreciate over time if they’re well maintained and in a good location.
Commercial real estate properties can increase in value based on the net income that the property produces. In short, the more money your tenants make, the more money you make as the landlord.
Even in situations where you’re not able to increase rent for the duration of the lease, designing your property to meet the needs of your tenants will give you more leverage to increase rent prices in the future.
Get Creative: Layer Wealth Building Tactics With Your Commercial Rental Investment
Real estate remains one of the best investments for people looking to generate wealth in time for early retirement. Unlike stocks, real estate leaves you with a tangible product, making it more secure than shares in a company. Additionally, people tend to understand real estate more efficiently. After all, everyone needs a place to live. By building a solid investment foundation in commercial real estate, you can provide yourself with creative freedom in the rest of your investments.
CRE Makes for a Balanced Portfolio
You never want to put all your eggs in just one basket when it comes to investing. For example, you wouldn’t want to dump your entire savings account into a start-up tech company. While the potential payoff would be huge, you’d also be vulnerable to losing everything.
The stock market is unpredictable. Don’t be the investor that tracks every dollar change in their mutual trust account. Be the investor that’s confident in their stocks, knowing that they’re balanced out by stable, income-producing stocks.
Commercial real estate perfectly counterbalances a stock-heavy portfolio in almost all instances. Generally speaking, when stock and bond prices move, commercial real estate prices stay the same. This lack of correlation proves the effective diversification of a commercial real estate investment.
You can further diversify by investing in numerous types of commercial properties. Instead of making all retail investments, consider investing in a retail space, an office space, and an industrial space.
Optimize Commercial Real Estate Taxes to Retain Wealth
In addition to getting creative with diversification, you can also build wealth by being creative and proactive with your commercial real estate taxes. While federal and state tax laws apply to all forms of income in most states, certain tax benefits are unique to commercial real estate.
Most rental property investors will already be familiar with 1031 exchanges. Here’s how they work if you’re not: when an investor sells a property for more than they paid for it, they earn capital gains (a taxable form of income). According to section 1031 of the Internal Revenue Code, they can delay paying taxes on that income if they use the money to purchase another property.
Creative investors will immediately realize the benefit here. By leveraging 1031 exchanges, investors can develop a diverse portfolio of tax-deferred properties.
Additionally, income for rental properties is usually processed through an LLC, lowering the tax liability for the investor. Establishing an LLC allows individuals to reduce their taxable incomes by writing off expenses and depreciation.
The most hands-on investors will be excited to know that they can invest in real estate through a self-directed IRA as long as they’ve established an LLC and work with a custodian.
Commercial property taxes are calculated more tediously than residential buildings. Financial experts must file an annual income and expense form, which evaluates a variety of taxes. The form’s structure is quite thorough, and the information it contains ultimately determines a commercial property’s taxable value.
Keep Commercial Rental Income Up While Staying Hands-Off
The primary appeal of passive income is that it’s completely passive, leaving you free to enjoy an early retirement. Commercial landlords are free to be as hands-on or hands-off as they like. People who don’t want to deal with the daily duties of being a landlord or can’t be on-site to handle operation will be pleased to know that there are a few lucrative hands-off commercial real estate investing strategies.
Don’t Go Alone: Partner With a Commercial Property Manager
The most common hands-off strategy is also the most obvious: partner with a reliable commercial property manager.
While it’s possible to find a suitable property manager for any rental property, you’ll need to refine your search to get the best commercial property manager. These properties are often larger and more expensive than residential properties. Furthermore, the needs of the tenants in a commercial property vary significantly from the needs of residential tenants.
The maintenance requirements for commercial property are usually more involved than other rentals, so it’s essential to have a vast network of contractors. You’ll want to find a company that specializes in the equipment used in the industries of your tenants.
The legal requirements and leases are also more complicated for commercial real estate, so your management company should also have expertise in that field.
Beyond the specialty requirements of commercial real estate investments, you’ll want to look for a company with the same qualities you’d see in the best residential property management company. This includes:
- Local experience
- Open communication
- Positive reviews and references
- Proper licensing and insurance
Commercial REITs: The Ultimate Hands-Off Investment
If you’re looking for a genuinely hands-off option, you can always invest in a commercial REIT.
REITs are a great way to invest in commercial real estate without worrying about the day-to-day tasks of managing a property. You don’t even have to worry about the expenses of buying a commercial property.
Commercial REITs work identically to residential REITs. You purchase shares in the company, and they use the money to invest in various commercial properties. This gives you exposure to a wide variety of properties without doing any of the work.
Know the Risks of Commercial Real Estate & Avoid Them
While there are many benefits to commercial real estate investing, it’s essential to be aware of the risks. Learning about the risks isn’t meant to talk you out of investing in commercial real estate. It’s a way to make sure you get the most back for your efforts. There are three primary risks when it comes to CRE.
Market Risk
One downside of long commercial leases is that rental rates might drop during the timeframe. Tenants might want to rewrite their leases for lower terms when this happens. As the landlord, it’s your responsibility to make valuable improvements that justify the rental price paid, even if it’s above market averages.
Liability Risk
As public spaces, properties like warehouses, shops, and offices carry severe liability for accidents on the property. For example, if you own a warehouse and a construction fault injures a worker, you could be held responsible. Minimize your risk by conducting regular property inspections.
Replacement Risk
If you own a commercial rental in a rapidly growing market, you’ll enjoy the perks of increased rental prices and ample demand. However, a hot market draws intense competition. If the climate is too good to pass on, developers may construct new properties that compete with yours. That’s why it’s essential to keep all the amenities in your building on par with the latest trends.
Work With a Real Estate Lawyer
The best way to protect yourself from the risk of commercial investing is to partner with a skilled real estate lawyer.
A good lawyer will help you navigate the complicated world of commercial real estate. They’ll make sure your lease is watertight, walk you through insurance options, and be there to offer guidance if any legal problems arise.
Finding and working with a lawyer may seem daunting, but it’s worth it for the peace of mind.
Reach Your Financial Goals With Commercial Real Estate
Commercial real estate can be a powerful wealth-building tool, but it’s important to scale up slowly from residential real estate investments. By following these tips, you’ll be on your way to creating long-term passive income and building lasting wealth with commercial property.
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