So, you’ve tried your hand at residential real estate investing, and now you’re looking to expand your investment portfolio to include commercial real estate. What do you need to know to adjust your strategy accordingly?
First, commercial real estate has much more variety in the types of property available to investors than residential real estate. Sure, with residential real estate, there are different property types — from the brownstones that dot city blocks to stand-alone suburban homesteads. However, the utility, or rather intent, behind this type of property is monolithic — namely, residential.
Commercial real estate is a much broader category that encompasses everything from farmland to shopping malls, stand-alone restaurants, and the commercial spaces in skyscrapers, airports, casinos, and other complexes.
It’s why there are a few things you should become familiar with when dipping your feet into commercial real estate investing.
Common Equity in Commercial Real Estate Investing
Investors are generally able to finance their residential real estate investments without needing to pool their capital or take on large amounts of debt. This is because residential real estate is generally cheaper than commercial real estate.
Because of the high costs associated with commercial real estate investing, many investors pool their capital together in something called common equity through a private equity firm. Common equity is one of the four main financing methods used to acquire a commercial asset.
Common equity holders often do not have priority in repayment if a commercial property fails. However, if things go well, they’ll see a higher reward. It is this higher risk, higher reward that makes investing in common equity attractive to smaller investors.
Understanding the Cap Rate in Commercial Real Estate
The capitalization rate is a metric used by investors to compare the return on investment (ROI) between similar commercial properties. Though the commercial real estate cap rate is the most widely used metric to compare similar commercial properties quickly, it ought to be used in conjunction with other metrics to paint a clearer picture of a property’s potential ROI.
It is a mistake for newer commercial real estate investors to rely on the cap rate alone. In truth, there is no good or bad cap rate that can be blanketed over all commercial properties. The specifics of a cap rate depend entirely on the commercial context of a property and the investment principles of the investors.
Making the Switch
Incorporating commercial real estate investments into your investment portfolio can be a lucrative and rewarding endeavor. However, you shouldn’t make such a move without knowing the risks involved. For many newer commercial real estate investors, seeking common equity through a private equity firm is the best way to get started.
About the Author
Veronica Baxter is a writer, blogger, investor, and legal assistant operating out of the greater Philadelphia area.