What Makes Commercial Real Estate Investing So Difficult?
Table of Contents
Why Commercial Real Estate Is Perceived As So Difficult.
Many investors swear that commercial real estate (CRE) investing is a lucrative venture that offers substantial returns and portfolio diversification. However, there are many challenges to overcome before you can enjoy these benefits.
Before we discuss what makes commercial real estate investing so difficult, let us have a brief look at what this investment strategy is and how it works. For those who want managed real estate investing solutions, consider BAM Capital. An accredited investor fund that specializes in multifamily syndication. Now, let’s jump back into discussing commercial real estate and why people think it is difficult.
Commercial real estate investing involves the purchase, ownership, management, rental, and/or sale of real estate properties that are used exclusively for business-related purposes or to provide a workspace rather than a living space. [1]
This type of investment specifically focuses on commercial properties such as office buildings, retail centers, industrial properties, and special-purpose buildings like hotels and medical facilities. These properties are leased to tenants to conduct income-generating activities. [1]
In addition to income potential, commercial real estate investing offers opportunities for significant value appreciation. Investors can enhance property value through strategic improvements and improved management practices.
Investors should take note that commercial real estate investing comes with higher risks and requires substantial capital investment. Successful investors typically conduct extensive market research, financial analysis, and due diligence to evaluate potential investments.
What Makes Commercial Real Estate Investing So Difficult?
When it comes to commercial real estate, one of the biggest advantages is its attractive leasing rates. CRE can have impressive returns and strong monthly cash flows, especially in areas where the amount of new construction is limited by either land or law. [1]
Commercial real estate also benefits from longer lease contracts with tenants compared to those of residential real estate properties. With long-term tenants occupying the building, investors can enjoy a considerable amount of cash flow stability. [1]
Despite its benefits, commercial real estate investing is not for everyone. It requires significant financial resources, a deep understanding of market dynamics, and the ability to manage properties effectively.
Therefore, while it can offer substantial returns and diversification benefits, commercial real estate investing is best suited for those with the necessary financial backing, expertise, and risk tolerance to navigate these challenges.
Here are some of the reasons why CRE is considered a difficult venture in real estate:
High Capital Requirements
One of the most significant barriers to entry in commercial real estate investing is the substantial amount of capital required. Unlike residential real estate, which often allows for individual or small-scale investments, commercial properties demand substantial upfront capital. Commercial properties tend to be more expensive than residential properties in the same area. [2]
This includes not only the purchase price of the property but also significant costs associated with renovations, maintenance, and compliance with commercial regulations. With more tenants, there are more facilities to maintain and therefore more costs. Investors typically need to secure large loans, adding layers of complexity to the financial structure. [2]
Additionally, commercial properties often have longer vacancy periods and higher tenant turnover rates. This means a robust financial cushion is needed to cover these gaps. These high capital barriers make it difficult for many investors to enter the market and sustain their investments over time.
Complex Financing Options
Complex financing options contribute to the challenging nature of commercial real estate investing. Financing is relatively straightforward with residential real estate with standard mortgage products. However, this is not the case for commercial real estate financing, which involves a myriad of intricate financial instruments and structures.
Investors must navigate through various types of loans such as bridge loans, interest-only payments, balloon payments, mezzanine financing, and commercial mortgage-backed securities (CMBS), each with its own set of terms, interest rates, and qualification criteria.
Commercial loans also tend to require more extensive documentation, higher down payments, and stringent creditworthiness assessments. Lenders scrutinize numerous factors including the property’s potential income, the borrower’s creditworthiness, and the business plan. [2]
On top of all that, investors also have to contend with fluctuating interest rates, prepayment penalties, and the need for significant equity investment, which can complicate cash flow management and financial planning.
Market Knowledge and Research
Success in commercial real estate hinges on an investor’s ability to understand and predict market trends. A commercial real estate investor needs to have a nuanced understanding of various sectors like retail, office space, industrial properties, etc.
Each sector operates differently and is influenced by distinct economic indicators, demographic shifts, and regulatory changes. Investors have to analyze market conditions thoroughly, including supply and demand dynamics, local economic health, and the competitive landscape. This will help them identify lucrative investment opportunities.
Once they have found a few choices, they need to evaluate the potential income generation from those prospective properties, including factors like tenant stability and lease terms. [3]
This level of detail demands continuous learning and staying updated with market trends, making it a sophisticated and often daunting endeavor even for seasoned investors.
Successful commercial investors understand that commercial real estate is valued differently compared to their residential counterparts. The income from commercial real estate is typically related to usable square footage. This, plus the fact that commercial property leases tend to last longer than residential leases means that CRE has the potential to earn a higher income. In order to reap these benefits, investors must do their research and learn about the risks and rewards of CRE. [3]
Management Intensive
Owning commercial property involves more than just passive investment. CRE is challenging due to its management-intensive nature. The level of management required for commercial properties is more similar to multifamily properties such as apartment communities and condominiums due to the large number of units and tenants.
Commercial real estate demands a higher level of hands-on involvement and expertise. Property owners must juggle various responsibilities, including leasing spaces, maintaining the infrastructure, ensuring compliance with regulations, and managing tenant relationships.
Each tenant may have unique requirements and expectations, from specific build-out needs to varying lease terms. The stakes are also higher due to significant financial investments and more substantial operational costs. Investors who wish to make a profit from CRE must learn to manage the property.
Most investors are not prepared to handle the maintenance issues of a commercial property. This means they need to hire someone to help with property management. This is an added expense, but it is necessary to ensure that the property is being managed properly. [2]
Risk Factors
Just like other real estate investments, commercial real estate is subject to various risk factors, including market volatility and economic downturns.
Market volatility can significantly impact property values and rental income, making it difficult to predict returns. Economic downturns, changes in interest rates, and fluctuations in demand can also contribute to financial instability.
We have discussed the high initial capital requirement and the complexities of property management. But beyond those concerns, investors also have to worry about inflation, employment rates, and regulatory issues, such as zoning laws and environmental regulations.
Illiquidity
Real estate, in general, is an illiquid asset class, and commercial properties are even more so. Unlike stocks or bonds, which can be bought or sold relatively quickly on public exchanges, commercial real estate investments often require a lengthy process to find a buyer or seller.
This lack of liquidity can tie up capital for extended periods, limiting flexibility and hindering investors’ ability to respond swiftly to changing market conditions.
Additionally, the illiquid nature of commercial real estate makes it more challenging to accurately assess its value. This is because market conditions and property-specific factors can fluctuate over time. Investors must therefore conduct thorough due diligence and carefully consider their investment horizon before committing capital to commercial real estate ventures.
Tips for Commercial Real Estate Investing
Because of all the challenges mentioned above, real estate investors must be careful before committing their capital. To further mitigate the risks of commercial real estate investing, here are some tips to follow:
Location, Location, Location: Just like in residential real estate, location is key in commercial real estate. Research the local market to identify areas with strong economic growth, high demand for commercial space, and potential for future development. [3]
Don’t Forget Due Diligence: Conduct thorough due diligence on any property you’re considering investing in. This includes inspecting the physical condition of the property, reviewing financial records, assessing market demand, and understanding zoning regulations. [3]
Consider Tenant Quality: The quality and stability of your tenants can significantly impact your investment returns. Look for properties with reputable tenants, long-term leases, and low vacancy rates. [3]
Diversify Your Portfolio: Consider diversifying your commercial real estate portfolio across different property types (e.g., office, retail, industrial) and locations to spread risk and maximize returns.
Plan for Vacancies: Vacancies are inevitable in commercial real estate. Make sure you have a plan in place to cover expenses during periods of vacancy, such as setting aside a reserve fund or having a strong leasing and marketing strategy. [3]
Investing in commercial real estate requires careful planning, patience, and diligence. Don’t hesitate to seek advice from experienced professionals, such as real estate agents, attorneys, and financial advisors, to help you make informed decisions.
The Best Real Estate Investment for Accredited Investors: Multifamily Syndication
Commercial real estate investing is not for the faint of heart. It requires substantial capital, in-depth market knowledge, and the ability to navigate complex financial and regulatory landscapes. If you are an accredited investor and you want to avoid all of these complexities, you may want to look for better alternatives. Read our article, “How to Become An Accredited Investor”, to learn more.
For those who would prefer a passive investment in real estate, multifamily syndication is one of the best options. Multifamily syndication allows investors to enjoy all the benefits of owning real estate but without the headaches associated with it.
Real estate syndication involves multiple investors pooling their funds together to purchase a single real estate property. This can be done with any type of real estate property, but multifamily syndication is the most popular among investors due to their strong and predictable cash flow. [4]
Multifamily properties are larger, more expensive, and more difficult to manage for a lone investor. But a real estate syndication deal makes them more accessible because there are several investors involved. This investment strategy lets you invest in real estate properties that are normally out of reach. [4]
Even high net worth individuals (HNWIs) may think twice about purchasing a multifamily property on their own, given that these properties can easily cost millions of dollars. If you do not want to take on all of this risk alone, a multifamily syndication is the way to go.
In a syndication deal, investors do not even have to worry about property management. The syndicator or sponsor who puts everything together is also in charge of property management. Investors can just sit back, relax, and enjoy their investment.
In a syndication deal, the syndicator acts as the general partner (GP) and takes on all of the responsibilities from creating the business plan to executing it. They will put the deal together, locate the investment property, conduct due diligence, secure the loan, and look for accredited investors who will provide most of the capital needed to acquire the multifamily property. [4]
In exchange for their investment and paying certain fees to get the syndication deal going, accredited investors earn a portion of the property’s cash flow. This may be distributed on a monthly or quarterly basis. Depending on the deal structure, investors may also earn a share of the equity upon resale. [4]
Keep in mind that every deal is different, so investors should still perform their due diligence. Make sure you carefully assess the private placement memorandum (PPM) or syndication agreement before participating in a syndication deal.
Beyond their initial investment, accredited investors no longer have to get involved. They serve as limited partners (LPs) in the deal and therefore have limited liabilities. This is a safer way to invest in real estate because you don’t have to deal with the challenges of running a multifamily apartment community by yourself. You also do not have to take on all the risk by yourself.
If you want to add multifamily real estate to your investment portfolio but do not have the time or energy to become a landlord and handle tenant concerns, multifamily syndication may be the best choice for you.
Work With BAM Capital for the Best Multifamily Real Estate Syndication Deals
Most multifamily syndication deals are exclusive to accredited investors because despite their benefits, they are not without their risks. For example, multifamily properties are still affected by illiquidity, so investors must be comfortable with not having access to their funds for several years. Syndication deals tend to last for a long time, so accredited investors need to be comfortable with a bit of illiquidity.
Accredited investors have the investing knowledge and experience to properly assess these investments. They also have the income and net worth to protect themselves in case a deal does not work out.
The best way for accredited investors to protect themselves when investing in multifamily syndication is to choose a trustworthy syndicator. After all, the syndicator will be the one to make all the decisions in the deal.
Work with BAM Capital if you want a syndicator that has a reputation for being a leader in its industry. BAM Capital is known for its reliable track record for excellence. In fact, BAM Capital now has over $700 million AUM and 5,000+ units. [5]
This Indianapolis-based syndicator focuses on high quality multifamily real estate properties that are Class A, A-, and B++, particularly those with proven upside potential and in-place cash flow. BAM Capital also uses an award-winning investment strategy that creates forced appreciation while mitigating investor risk. [5]
BAM Capital is also a vertically-integrated company, meaning they can guide you through the entire syndication deal, from step of the syndication process, from acquiring the properties to renovating and managing them.
No investment is without risk. Make sure to consult your investment advisor or speak to a BAM Capital investment team member before making any financial decisions.
For accredited investors who want to enjoy the passive income and all the other benefits of being in a multifamily syndication, schedule a call with BAM Capital and invest today.
Sources:
[1]: https://www.investopedia.com/terms/c/commercialrealestate.asp
[2]: https://www.nolo.com/legal-encyclopedia/pros-cons-investing-commercial-real-estate.html
[3]: https://www.fortunebuilders.com/how-to-invest-in-commercial-real-estate-getting-started/
[4]: https://multifamilyrefinance.com/apartment-investing-blog/multifamily-syndication#important
