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Investment Variables in Commercial Real Estate
When it comes to making a decision on whether to invest in a commercial property, there are a variety of variables that an investor can take into account. First and foremost, in many cases, is return on investment, which calculates the amount of money that a investor will make compared to the amount of money they’ve invested into the property, minus any expenses. Other variables include the safety of an investment property, a property’s development potential, the property’s location, and an individual investor’s financial instincts.
What are the Most Important Investment Variables in Commercial Real Estate?
When it comes to making a decision on whether to invest in a commercial property, there are a number of variables that an investor can take into account. First and foremost is return on investment. This calculates the amount of money that an investor will make compared to the amount of money they’ve invested into the property, minus any expenses. Other variables include the safety of an investment property, a property’s development potential, the property’s location, and an individual investor’s financial instincts. In this post, we’ll review all of these in order to enhance your understanding of each.
Return on Investment
Return on investment, also known as ROI, is usually determined by using the formula below:
ROI= (Investment Gain - Investment Cost)/Cost of Investment
ROI can also be determined in a variety of other ways, including by looking at a property’s cash on cash returns, its cap rate, or even its gross rent multiplier (GRM). In general, most commercial investors prefer a cash on cash return of at least 12%, although this can vary based on the risk of an individual investment. Likewise, acceptable cap rates and gross rent multipliers also vary greatly based on the specifics of an individual investment property.
Safety of Investment
The safety of an investment is another huge factor in deciding whether purchasing a property is a good idea for an investor. There are a couple of factors to look at here, including an investor’s personal knowledge of the real estate in a particular area. For example, if you were to buy a commercial property in your neighborhood, where you’ve lived for years, it could be much safer than purchasing property in another state, where you are much less familiar with the market.
The riskier the investment, the higher rate of return you should expect. For instance, if you were purchasing a Class B or C office building in a somewhat run-down or up-and-coming area, you would want a significantly higher rate of return than you would for a premiere, Class A office building in an expensive metro area.
Development Potential
How much can you improve a building once you’ve purchased it? And how much will those improvements translate into an increased market value? If the answer is “a lot,” then your property may have a lot of development potential. If we take the example in the paragraph above, the premiere Class A building may not have much development potential, since it’s already a top-of-the-line property. However, a Class B office building might have a lot of room for improvement. For instance, if you were to purchase a building for $2 million and you estimated that with $400,000 in improvements, you could sell the property for $3.5 million, the property would have a significant amount of potential for development.
Location
When buying a home, it’s common to hear that the three most important factors are “location, location, location.” That saying applies equally to commercial real estate. However, there are certain factors that may influence a property’s location-based value for certain buyers. For instance, if a buyer is a business owner who wants to use the property for their business, they may be willing to spend significantly more, as a property in a certain location could add a big boost to their business.
Financial Instincts
While ROI, cash-on-cash returns, development potential, and location can tell an investor a lot of the story, many experienced investors also rely on their gut feelings (as well as other market information) in order to make a decision on a property. Of course, because some investors have a much higher risk tolerance than others, a great investment for one individual, group, or company, could seem disastrously risky for another.
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Related Questions
What are the most important variables to consider when investing in commercial real estate?
When it comes to making a decision on whether to invest in a commercial property, there are a number of variables that an investor can take into account. First and foremost is return on investment. This calculates the amount of money that an investor will make compared to the amount of money they’ve invested into the property, minus any expenses. Other variables include the safety of an investment property, a property’s development potential, the property’s location, and an individual investor’s financial instincts.
What are the risks associated with investing in commercial real estate?
Commercial real estate is generally considered to be a higher-risk investment due to the potential for tenant default and the longer lease terms. Leasing velocity is much slower than in multifamily or single-family residential real estate, and so a vacant building may take longer to completely fill than a residential property.
Other risks associated with investing in commercial real estate include:
- Market volatility
- Interest rate fluctuations
- Inflation
- Changes in local economic conditions
- Changes in zoning laws
What are the tax implications of investing in commercial real estate?
Investing in commercial real estate can have a variety of tax implications. One of the most important things any commercial real estate investor should do is find a qualified tax professional who knows and understands the field. Working with a professional can help you reduce your levels of stress and use some of the best strategies when it comes to taxes and your property.
When it comes to taxes, you can deduct employee wages, independent contractor costs, and professional fees. This includes things like legal fees, property management fees, and accounting fees. Additionally, if you pay an independent contractor more than $600 in a single calendar year, you will have to send and file 1099s for them.
It is important to note that tax laws are constantly changing, so it is important to stay up to date with the latest changes and work with a qualified tax professional to ensure you are taking advantage of all the available deductions.
What are the potential returns on investment for commercial real estate?
The potential returns on investment for commercial real estate vary greatly based on the specifics of an individual investment property. Generally, most commercial investors prefer a cash on cash return of at least 12%, although this can vary based on the risk of an individual investment. Additionally, acceptable cap rates and gross rent multipliers also vary greatly based on the specifics of an individual investment property.
You can learn more about Return on Investment in Commercial Real Estate and Investment Variables in Commercial Real Estate.
What are the different types of financing available for commercial real estate investments?
There are many types of commercial property loans available for commercial real estate investments. These include debt fund loans, bridge loans, SBA loans, and traditional bank loans. Each has unique upsides and downsides, and every investor should weigh all options available to make the best financing decision for their strategy.
Debt fund loans are a type of financing that is provided by private debt funds. Private debt funds are typically composed of a group of investors who provide financing to businesses and organizations in the form of loans. Loans from debt funds generally cover financing scenarios that many other lenders, like banks, may shy away from. This could include lease-up financing for multifamily properties, or a loan to rehabilitate an office asset.
Bridge loans are short-term loans that are used to finance a property until a more permanent form of financing can be obtained. These loans are typically used to purchase a property quickly, and can be used in situations where a more traditional loan may not be available. Bridge loans are typically more expensive than traditional loans, and may require a higher down payment.
SBA loans are loans that are provided by the Small Business Administration. These loans are typically used to finance the purchase of a business or commercial property. SBA loans are typically more expensive than traditional loans, but may offer more flexible terms and lower interest rates.
Traditional bank loans are loans that are provided by banks and other financial institutions. These loans are typically used to finance the purchase of a business or commercial property. Traditional bank loans are typically more expensive than SBA loans, but may offer more flexible terms and lower interest rates.
What are the advantages and disadvantages of investing in commercial real estate?
Investing in commercial real estate can be a great way to diversify your portfolio and generate income. However, it is important to understand the pros and cons of commercial real estate before making an investment.
The main advantage of commercial real estate is the potential for higher returns. Commercial properties tend to have higher rental rates than residential properties, and the longer lease terms can provide a steady stream of income. Additionally, commercial properties tend to appreciate in value more quickly than residential properties.
However, commercial real estate is generally considered to be a higher-risk investment due to the potential for tenant default and the longer lease terms. Leasing velocity is much slower than in multifamily or single-family residential real estate, and so a vacant building may take longer to completely fill than a residential property. Additionally, commercial real estate investments require more capital than residential investments, and the financing terms are often more complex.