The 5 Best Commercial Real Estate Investment Strategies
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Commercial real estate offers many different investment strategies.
There are almost an unlimited amount of different ways you can invest depending on asset type,
property class, location, investment strategy, and more.
Finding the right investment strategy for you is very important.
Here are the 5 best commercial real estate investment strategies:
* The Commercial BRRRR * Development
* Land Banking * Long-Term Buy and Hold
* Owner-Occupied Depending on your goals, you may choose to
stick with one method or diversify with multiple strategies.
1. The Commercial BRRRR ________________
The BRRRR method was made famous by BiggerPockets. This strategy is the one that I tend to lean
toward when evaluating my own investments. BRRRR is also known as value-add and stands
for: * Buy
* Rehab * Rent
* Refinance * Repeat
The BRRRR strategy is very scalable and can be used on single tenant office buildings
to garden-style apartments with hundreds of units.
Buy An Undervalued Property The key here is to find a property that is
undervalued. This property could be in a distressed-seller
situation, but likely needs a significant amount of value add.
You’ll want this investment at well below replacement costs.
Renovate The Building The second step of the BRRRR method is to
renovate the building. Now - keep in mind that you’re not renovating
to the comps. You’re simply renovating to increase the
perceived value to tenants. The most common renovations for commercial
buildings include: * Interior and Exterior Paint
* Updated Flooring * New Signage & Directories
* New Lighting While you may want to renovate above and beyond
that, those few updates will make any building look brand new.
Rent The Space To Tenants Now that you’ve updated the look and feel
of the building, time to get it leased. Unless you have a background in commercial
leasing, it’s best to lean on a leasing brokerage or property management company here.
The quicker that you can lease out the space, the faster you can move on to the next step.
Refinance The Investment Now for the fun part.
After you’ve renovated the building and leased it up, it’s time to pull all of your
cash back out of the investment. That’s right.
If you performed the earlier steps right, you should be able to refinance based on a
cap rate and pull all your initial capital out of the deal while still owning the building
and receiving that cash flow. Repeat The Process!
You’ve got your capital back. You’ve built up your balance sheet.
Time to repeat the process again and build that portfolio of commercial real estate.
2. Development ________________
Development allows you to completely re-imagine a piece of land.
You may be creating that project from a raw piece of land or re-envisioning what already
exists on the property. However, development is very risky.
While it has the most potential to create wealth in real estate, it also has the highest
potential for you to lose everything. It’s crucial that you understand what you’re
doing and have the right team. Buying The Dirt
The first step in real estate development is finding the dirt.
There are many points of consideration when finding the ideal piece of land for your project:
* Location * Zoning
* Topography * Utilities
* Traffic * Demographics
And that’s an oversimplification of what you need to investigate.
Each of these items will determine not only if your project will be successful, but whether
or not you can actually even develop the site in the first place.
Creating The Site Once you’ve found the ideal parcel that
fits your criteria, it’s time to put your vision to work.
At this stage, you’ll be working closely with a civil engineer, an architecture firm,
and your leasing / sales team. These advisors are crucial to determining:
* Development Feasibility * The Proper Site Layout
* The Horizontal and Vertical Design * Your Marketing Strategy
The most successful developers have a curated team of experts surrounding them, which allows
them to better coordinate the many different aspects of real estate development.
Securing Construction And Development Financing Commercial lenders want to see an outstanding
track record. Especially considering how risky commercial
development is. After all - they’re not in the development
business and don’t want to have to step in halfway through a job to see it through
completion if you go bankrupt. Your team and strategy will be of utmost importance
here. In addition to your engineers, architects,
and leasing / sales team, lenders will review: * Your Operational Team
* Your Financial Partners * Your Project History
Having an excellent presentation will give your lender peace of mind and help you better
plan for the success of your deal. Overseeing The Construction
Your team will help you oversee the construction of the site.
Doing so will ensure that the project is built to your standards and should help keep the
project closer to its original development timeline.
Choosing the right general contractor should be high on your priority list.
If your project runs into unexpected delays, cost overruns, or shoddy work, your pockets
will take a major hit. This contractor will manage:
* Horizontal Site Development (moving dirt, placing all utilities)
* Vertical Site Development (the bricks and sticks of the building)
* Interior Finishes and Warranties Marketing And Completion
While under construction, your team should hit the ground running with a marketing plan.
Whether you’re leasing or selling these units, any and all pre-sales / pre-leases
you can possibly get will significantly reduce your risk.
Not to mention create momentum. Activity breeds more activity and if prospects
don’t see much movement on the property, it could make them wonder why no one else
is interested. Be sure to interview and hire the best leasing
or sales team in your market that has a solid track record and understanding of your product
type.
3. Land Banking ________________
Land banking is an investment strategy for patient and hands-off investors.
Essentially you buy land in the path of development and wait.
No late night maintenance calls. No building repairs. Very little work!
As the development moves toward you, your property increases in value and you then sell
it or partner with a developer to re-envision the property.
Your investment in the land is basically a bank account secured by the dirt.
Qualifying The Land When placing capital in dirt for the land
banking strategy, you need to choose carefully. Be sure to unders w zoning and planing works
within your municipality, as that will determine whether your investment will be successful
or not. Review those documents to see how the city
views the future of different districts. If the city has a plan for the future of an
area where they intend to turn farmland into a high density commercial area or run a major
thoroughfare from the interstate, it could be an opportunity to land bank.
Should You Finance The Deal? Some investors choose to place debt and leverage
their land investments. Others simply pay all cash.
The path you take is completely up to you. There’s certainly something to be said for
owning a piece of dirt outright when it isn’t producing any income.
Many land bankers found themselves in trouble in 2008 when they had to continue paying mortgage
expenses, taxes, property insurance, and maintenance without any money coming through the doors.
However, if you can leverage and place the remaining capital in a different investment
that will pay for your carry costs on this land, that could be a solid option.
Planning For The Future When land banking, you’ll certainly want
to maintain the image of your land. Be sure to keep the grass mowed, trash cleaned,
and remove any squatters from the dirt. You never know when your land will become
valuable to someone else. And you’ll want to strike at that opportunity.
While waiting for the value to increase, you could also put together proposed plans for
the development of the site. These plans will help any brokers, developers,
and visionaries see what could be placed on the site, which could make it more attractive.
4. Long-Term Buy And Hold ________________
The long-term buy and hold has the most creative name on the list.
You buy an investment and hold it for the long-term.
You can utilize this investment method with single-tenant net properties and skyscrapers,
alike. There are different reasons to invest in different
buildings depending upon how involved you’d like to be in the day to day operations.
Determine What Type Of Property You’ll Invest In
The beauty of this strategy is that it can be used on any kind of property.
Whether you’re looking to buy Class A office space downtown at a 4.5% cap rate or a distressed,
suburban shopping center with 52% vacancy, it could work.
Here are a few factors to consider: * Your Involvement - If you want to be more
active, you may be able to achieve higher returns on your investment. However, you can
only invest in your area. If you’d like to take a hands-off approach, you can purchase
single-tenant absolute net investments anywhere in the country.
* Risk Tolerance - Are you looking to aggressively grow your wealth? If so, you may be more willing
to take risk. If, on the other hand, you’re simply looking to maintain your wealth, you’ll
want to place capital in a more stabilized asset.
* Your Overall Goals - Do you intend to hold this property forever? You may take a different
maintenance and leasing strategy for the investment than if you plan to sell in the next 10 years.
Underwrite The Investment You’re typically buying long-term hold investments
for the cash flow they produce. So, it’s critical that you properly underwrite
the investment and examine any risks involved with the asset.
Review the leases in-place and consider the length of term, tenant credit, bumps in rent,
and any future vacancies that could arise. If you’re unsure about how to underwrite
a commercial real estate investment, work with a commercial real estate brokerage or
hire an underwriter to assist you. Ongoing Operations Of The Property
As the investor, you likely won’t want to be involved in the day to day operations.
Especially if you intend to purchase more commercial property.
From day one, you should hire a property management company and a commercial leasing team (if
necessary) to oversee the ongoing operations onsite.
Hiring an outstanding property management company can make all the difference with regards
to: * Excellent Tenant Relations
* Lower Vacancy Rates * Preventative Maintenance
* Financial Reporting and Taxes They’ll work hand-in-hand with your leasing
team to ensure that your investment performs at its absolute best.
And they’re incentivized to do that! If this investment is successful, chances
are good you’ll buy more for them to oversee.
5. Owner-Occupied ________________
Ever heard of “house hacking?” Owner-occupied commercial real estate is the
exact same strategy. Except, for, you know, on commercial property.
You move your business in to the property, maybe lease to another tenant or two, and
use your business to help pay down the mortgage. Choosing The Right Site
When using this strategy, it’s important to find a building that also works for your
business. If your business can’t succeed or operate
out of the investment, you won’t have it for very long, anyway.
This strategy is almost a “business first, investment second” thought process.
These investments can be a multi-tenant situation or you could be in a standalone building - totally
your call. Most investors that take this route prefer
to have at least one other tenant, in addition to their business, to help cover the costs
of the building. How Financing Works
Depending on how much of the space you’re taking, you could use owner-occupied financing.
These terms are, for good reason, better than typical commercial loans.
Why? Because the lender’s risk is lower since
your business is operating there. Depending on your lender’s requirements
for owner-occupied, your business may need to inhabit at least 51% of the leasable space.
However, I’ve seen lenders offer as low as 30% of the space.
You’ll find interest rates and down payments are lower when exploring this investment strategy.