Investing In Commercial Real Estate Can Be Complicated

The Economist recently published a study that found the investment in residential property in developed countries far outpaced commercial real estate investments.  In fact residential investments totaled about $48 trillion dollars were as commercial investments had a much smaller amount at about $14 trillion dollars.  This is most likely due the fact that commercial real estate investing is much more complex.

Investments in stocks or commodities are not geographically based unlike real estate.  Real estate takes up a physical location and is part the make-up of a particular area.  Even though the investor may not be local the property always is.

The physical location of a property will always affect its value, its use and how it is bought and sold.  And although some residential properties can be bought for business purposes commercial real estate is almost always purchased to be used for a business purpose.

For instance an investor may purchase a multi-unit building such as an apartment complex.  To the residents of that property it is their home but in actuality it is a commercial investment.  This property is built on land that in specifically zoned for that purpose.  This will dictate its value, appraisal, financing options that are available to the investor, as well as maintenance issues and other factors.

Unlike buying residential properties, purchasing a commercial property will usually require that the investor come up with a much larger down payment and have better credit as commercial investing can be a higher lending risk.  Commercial investing also requires the investor to take into account other important factors such as Gross Rent Multipliers and Capitalization rates.

The Capitalization or cap rate is determined by taking the properties annual operating income and dividing it by its purchase price.  Traditionally a good cap rate was considered to be 10% or higher but in recent years, due to a lower expected return and greater risk in the market, a cap rate of 8% has been considered acceptable.  In the next part of the equation the Gross Rent Multiplier, or GRM, is arrived at by taking the properties monthly operating income and dividing that by the properties purchase price.  These two figures along with comparables, assessed versus appraised value, replacement costs and other factors are used to estimate the true worth of a commercial property.

Commercial real estate investing also requires more knowledge of such things as legal issues, zoning, maintenance, commercial financing and leasing regulations to name a few that are not involved in the normal residential real estate transaction.  Other matters will also come into play like large mechanical systems for electrical, fire suppression and security alarms, telephone and internet, and heating and air conditioning.  These can make insurance and maintenance not only for complicated but more costly as well.

But it is not all doom and gloom when it comes commercial real estate investing.  With greater risk can come greater rewards to the willing investor.  Even in periods of a slow economy an investor can find opportunities to grow their real estate portfolio in preparation for the stronger economy that is on the horizon.