A study published in The Economist indicated that commercial real estate investments are not as prominent as residential real estate in industrialized countries. In fact residential investments amounted about $48 trillion dollars were as commercial investments had a much smaller amount at about $14 trillion dollars. The complexity of commercial real estate investing is probably the leading factor for these findings.
Investments in stocks or commodities are not geographically located as opposed to real estate. In the case of real estate, it always occupies a specific physical area. A building is always local even though the investor may be from out of town.
The physical location of a property will always affect its value, its usage and how it is purchased and sold. Despite the recent economic slowdown, certain markets such as the GTA real estate market are still performing. And although some residential homes can be bought for business reasons commercial real estate is almost always purchased to be used for a business purpose.
Let’s take the scenario of a multi-unit building such as an apartment building in the Burlington Real Estate market. To the tenants of that building it is their home but in actuality it is a commercial investment. This property is built on land that in specifically zoned for that function. This will determine its value, appraisal, financing options that are accessible to the investor, as well as maintenance issues and other elements.
Unlike buying residential properties, buying a commercial building will usually require that the investor come up with a much greater down payment and enjoy better credit as commercial investing can be a greater lending risk. Capitalization rates and Gross Rent Multipliers should also be taken into consideration by the investor in the option of commercial investing.
Taking the building’s annual operating income and dividing it by the purchase price will bring you the Capitalization or cap rate. A cap rate of 10% or more has historically been deemed a good one however because of the market’s increased tolerance to risk and accepted lower return in recent years, a cap rate of 8% is acceptable. In the next part of the equation the Gross Rent Multiplier, or GRM, is arrived at by taking the property’s monthly operating income and dividing that by the building’s purchase price. Other elements such as assessed value versus appraised value, comparables, replacement costs and the two figures explained above are used to determine a commercial property’s true value.
Unlike normal residential real estate transactions, commercial real estate investing will demand more understanding of factors such as legal issues, maintenance, zoning, leasing regulations, commercial lending among others. Other factors will also come into play like large mechanical circuits for electrical, fire suppression and security alarms, telephone and internet, and heating and air conditioning. Maintenance and insurance can be made more complicated and more expensive by these factors.
Real estate investing is not, happily, all doom and gloom. With greater risk can come higher rewards to the predisposed investor. A real estate investor can discover opportunities to increase their real estate portfolio even during periods of slower economy as the economy is pegged to rebound in the near future.
