When it comes to investing your hard-earned money into commercial real estate, there are a few things that you need to be aware of to give you the most likelihood for successful investments. The following tips are in order of priority, and you’ll notice that location isn’t even in the top three!
First and foremost, real estate is a physical property investment, meaning that it’s not like stocks or bonds where you can sell them anytime you want. Liquidity is why certain investments are allowed in individual retirement accounts and other illiquid investments are not. Real estate is a commitment of 3-10 years, so patience is key.
If you are using real estate for retirement, you can focus on cash-flowing properties in good condition with strong rent collections rather than long-term value-add properties needing a lot of construction: it’s up to you and your goals.
The longer your money is tied up without cash flow, the higher the returns should be to compensate. The more money you receive from rent distributions, the lower the total returns typically are. One investment that does both is a unicorn worth looking for, but usually it’s a better strategy to include several different types of investments to meet a variety of goals.
Real estate is “real,” meaning physical buildings and land each with their own unique circumstances or “personality” like age and condition, or unique geotechnical factors.
Properties are complex and require regular maintenance, which means you need to be prepared for unforeseen situations and details you might not be made aware of when investing in other complex businesses like the stock market. That means your managing team’s experience is extremely important!
The more experience someone has dealing with these types of investments, the better chance they have to successfully execute their business plan. It’s important to keep in mind how many people are involved in any given deal from the operations team to the property manager to the residents themselves.
It’s essential to vet the operators and managers very carefully before making an investment. Do background checks on every managing team member, find out who’s handling the finances, construction, and leasing oversight, check out the property manager’s reputation and on-site staff experience, and get to know them: are they in it for the money and prestige, or are they committed to providing great places for their tenants and great returns for their investors?
Usually these are the only three things to consider, but it’s actually fourth on the list of priorities! Making sure the market has a growing population, that the neighborhood is clean, safe, close to a wide variety of jobs and strong schools is absolutely critical if you hope to succeed as an investor in commercial real estate.
Finally, evaluate the financial fitness of the project by verifying the projected returns are based on accurate inputs.
Learn the basic financial metrics like IRR, Cash on Cash Return, and Equity Multiple, as well as the terms of the loan and payback period. This includes reading the legal disclosures and understanding the business plan such as the scope of renovations, replacing tenants, competitors, new job centers, city policies, and more.
You can really dive down a rabbit hole here, so just start by learning about one metric, and keep going from there!
Okay, here’s a bonus section that might be longer than the rest of this list! Your research process won’t guarantee any given investment is successful, so the last tip is to diversify your portfolio using the following suggestions to minimize risk from any one placement not performing.
Find 5-20 different investments to spread your designated commercial real estate investing funds across: you’ll typically need 15-30 to completely replace your income with passive cash flow!
Choose 4-6 operations teams you have thoroughly vetted and trust
Choose 2-5 strong metropolitan areas
Invest 2-3 different property types such as multifamily, self storage, office or medical, warehouses, retail and restaurant, mobile home or RV parks, etc
Avoid going overboard on diversification as it’s not only extremely time consuming to vet new teams, new markets, new niches, it can create analysis paralysis, and no one can be an expert at everything. Specialize in just a few things with a little bit of off-the-wall investments thrown in to help you grow, so you can make decisions based on confident experience!
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