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Even if you’re inexperienced in commercial real estate, it’s one of the most reliable investments you can make to build significant net worth over time. However, you can lose your shirt if you don’t know what you’re doing.
I had a successful career as a CRE professional, but I also learned from my mistakes over the years. I’ve outlined five essential tips that will help you avoid the same critical mistakes and take advantage of the wealth-building potential of commercial real estate ownership.
Related: How to Start Investing in Rental Properties – Your Step-by-Step Guide
4 Ways Commercial Real Estate Can Make You Money
Many commercial real estate transactions involve passive investors. As a passive investor, you don’t need a real estate license or law degree. The key is to have the highest possible level of trust in the asset, the market and the people you are dealing with. Always team up with a proven professional who knows the dynamics of the local market until you learn how to identify, structure and fund a deal on your own. You should also have a good real estate lawyer to ensure that your contracts are complete and compliant, thus protecting you from any unpleasant surprises.
The average returns generated by smart, well-structured commercial real estate transactions typically exceed all other investment categories over time. Commercial real estate generates monetary value and builds equity in four key ways:
- Cash flow: Cash flow for each property is calculated based on the property’s rental income, less operating and maintenance expenses (net operating income), capital expenditures and maintenance service payments. debt.
- Debt refund : Debts such as mortgages or private financing allow the buyer to invest less money in the asset, which can improve the return on investment. The “leveraged cash flow” reflects property income as debt service is paid off. Once the debt is paid off, the property generates unleveraged cash flow for a superior return over the period of ownership.
- Asset Appreciation: While cash flow can provide a steady return to investors, asset appreciation can also increase the value and income generated. Appreciation may be the result of market forces when local price valuations increase, or through an increase in the property’s net operating income, achieved by reducing expenses, increasing on-site revenue opportunities, or both.
- Tax depreciation: The US tax code provides tax credits for depreciation while the actual market value of the asset may enjoy overtime. This is why the wealthiest investors favor commercial real estate as a tax shelter strategy.
Related: 5 Ways to Start a Lucrative Real Estate Business
What to do for a successful real estate investment?
I made my first commercial real estate transaction when I was 18 years old. But I had a partner and a mentor without whom I would not have succeeded. Since then, I have been addicted to CRE. There is no other company that has the same power to impact net worth as deeply or reliably over time.
In addition to working with partners you trust, here are five things I’ve identified every new investor needs to do to be successful in commercial real estate investing and owning:
- Buy where demand is already high, preferably near you. I recommend properties that are no more than 30 minutes from a vibrant and growing employment base. Properties within a reasonably close distance of your home are much easier to monitor. Don’t rely on a property manager in another city to care about your investment as much as you do.
- Ensure your team’s market knowledge is comprehensive and due diligence is thorough. Due diligence on a particular property generally covers three categories: financial performance, existing leases and contracts, and the physical asset itself.. Make sure your business partner has an impeccable understanding of local trends for different types of commercial real estate assets (retail, office, industrial, multi-family), how everyone’s standards have changed with the evolution of demand and how that demand influences market behavior.
- Don’t be dazzled by shiny objects. Expensive, Class A property can be expensive to maintain. Sometimes there are more opportunities in non-shiny assets, such as industrial properties that require much less maintenance. Depending on the economic cycle, there may be more return on investment (and less risk) in a less attractive warehouse, workshop, distribution or storage property than in buildings with poorer interior design, materials and equipment. top of the line.
- Buy based on current performance and rental rates, not projections. Don’t be swayed by optimistic pro forma figures. Only look at revenue projections based on current market conditions, not the future. Nothing is guaranteed, but past and current market demand can provide a benchmark for assessing asset value and income potential.
- Keep leverage low and cash reserves high. I don’t prefer leverage above 50%, but up to 75% may be acceptable in the right market for the right property. I also recommend having enough cash in reserve for 12 months of debt service if cash flow is interrupted or delayed due to extended vacancies, government interventions, or other reasons. Keep a separate cash reserve for routine and unscheduled maintenance and repairs. Be prepared to cover damages, equipment failures, or costs related to extreme weather and other “unforeseen” events.
Related: 5 Reasons Every Entrepreneur Should Invest in Real Estate
Location and local market dynamics will always be key factors in the success of any commercial property and your investment in it. In the Triangle area of Raleigh, Durham and Chapel Hill, North Carolina, where our company is located, commercial real estate valuations have rebounded to above pre-pandemic levels and should remain well insulated against any downturn economic potential.
Commercial real estate has two speeds – fast forward and fast reverse. When done intelligently, there is no safer investment. A bad deal, however, can be financially devastating. Unless you’re an experienced CRE investor or developer, don’t do it alone. With the right partner, the right deal can change your life and create generational wealth for you and your family.