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
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
Common Equity in Commercial Real
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.