All the returns, none of the hassle: Commercial real estate investing seems like the sweet spot for individual investors. You are investing in actual buildings, so there’s the comfort of the tangible, and commercial tenants appear to represent steady income flow with, hopefully, less drama than small residential properties.
Commercial real estate also offers a wider scope of options than investing in single-family houses and small rentals. Best of all, you can tiptoe in with a relatively small initial investment, learn how this huge sector works and determine if it will help you achieve your financial goals.
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Commercial real estate investing 101
Commercial real estate spans multifamily housing — big apartment buildings — to buildings that are occupied by things, not people, such as warehouses. In between are retail, office, medical and other special-use buildings.
A commercial real estate holding consists of both the land and the building. Those are two points of value that anchor the investment. Even if one sector falls out of favor — as office buildings are now in the post-pandemic, remote-first world of work — buildings and land are still worth something.
That inherent value explains why commercial real estate accounts for about 15% of institutional portfolios, said Sam Adams, CEO and co-founder of Vert Asset Management, which creates and manages real estate investment portfolios. For individual investors, the recommended allotment usually ranges between 5% and 15%.
Typically, you can count on average annual returns from a real estate investment trust (REIT) of about 11% and, from private REITs, about 8% annually. A commercial real estate investment structured through a private partnership, or even that you own directly, is probably going to yield closer to 6% due to expenses, he added, though tax considerations might offset some of those expenses.
Real estate is “staid,” said Brian M. Spinelli, co-chief investment officer with financial advisory firm Halbert Hargrove. And many investors want staid because it balances out more volatile holdings, such as growth stocks.
In a way, said Spinelli, commercial real estate is “an alternative to fixed income,” because the steady stream of rental income is similar to the debt payments that flow to bondholders.
How to get started in commercial real estate
REITs, which own huge portfolios of properties, are a well-established mode of investing in real estate. Some REITs are publicly traded, which means that individual investors can buy and sell shares just like they can with any other fund. The minimum investment in a publicly traded REIT is simply the cost of a single share, and such funds are typically available through major investment platforms that handle all kinds of funds.
Specialty REITs concentrate in sectors such as health care, retail and multifamily housing, offering investors a chance to get in on promising trends. You can also chase other trends through specialty REITs, Spinelli pointed out, such as by investing in data centers, which are expanding rapidly to support artificial intelligence endeavors.
Other REITs include public non-listed REITs, which must be registered with the Securities and Exchange Commission (SEC) but are not listed on stock exchanges. The initial investment for a public non-listed REIT is often $1,000 to $2,500, according to the National Association of Real Estate Investment Trusts.
You can also create your own real estate investment partnership with other like-minded investors if you’re able to muster the money to buy a commercial property. If you do that, you will have to assemble a team of experienced accountants, real estate lawyers and, depending on how much work you want to do on your own, property managers.
Owning the property directly makes you the landlord, unless you pay a property manager to insulate you from daily issues like broken pipes and security. Property management, insurance, taxes maintenance and tenant management will all factor into your net returns.
Commercial real estate investment strategies
Often, explained Spinelli, huge REITs never mature. They’re a revolving door of properties, with new properties purchased and older holdings sold, in a continual rotation, capturing gains and, meanwhile, collecting income that supports investors’ returns. These big portfolios, when publicly traded, offer individuals a chance to hop in and out as they would any other publicly traded fund.
Investors who are in a position to leave their money out of reach for a while — usually institutional or accredited investors — might be interested in private REITs, which typically involve diversified funds that produce dividends to investors on a regular schedule but might only allow investors to exit at certain points. Privately traded REITs often lack the liquidity of their publicly traded counterparts.
“It’s not like logging on to your computer and hitting ‘sell,’” said Spinelli. You’ll have to manage the timing of a private REIT investment carefully, with the help of an advisor, to sync it with the rest of your portfolio. But many people simply park a chunk of money in a private REIT and let it roll over, added Spinelli, “if it’s part of their long-term portfolio.”
If you invest with just a few other partners or on your own, you will have to collaborate with a tax accountant and financial advisor to decide when and how to sell the property to maximize returns and minimize taxes. A classic strategy is to contain the gains in a “1031 exchange,” in which you roll the capital gains from one property immediately into another, presumably larger, property. That postpones capital gains taxes while you reap income from rent. But, if you want to cash out, the tax bill will come due. Navigating long-term capital gains taxes from a commercial property is a job for a professional.
Is commercial property a good investment?
Once you have a strong start with your employer-sponsored 401(k) plan and are building a portfolio outside of that, say advisors, consider how the long arc of real estate returns offset your other holdings. In advisor-speak, real estate is an “alternative” investment because the timeline of return and, often, illiquidity offset investments in funds and stocks that you can sell whenever you want.
Reading the prospectus for a REIT will help you get up to speed on real estate investing terminology. Tracking a few REITs and commercial property trends in areas that interest you will help you become conversant in real estate investing strategies and understand whether commercial property investments are right for your situation.
Remember that your own house is not really part of your investment portfolio unless you have adopted the fix-and-flip model of investing in single-family houses. While your primary house likely will grow in value, you are also paying along the way for taxes, insurance, upkeep and improvements. Those expenses are costs of living but also dampen the financial return you might eventually recoup from your house.
Frequently asked questions (FAQs)
Your best bet for getting in on commercial real estate at the entry level is through a REIT that is publicly traded. Another way to wade in is through online platforms like Fundrise, that enable individuals to buy a sliver of a startup company or real estate investment. Always consult with your advisor before investing, and always read the disclosure and prospectus for any investment.
Spinelli and Adams agreed that small-scale commercial real estate investing is a way to convert a hunch about a local trend into an investing opportunity — all the more reason to become conversant with this type of investment and establish relationships with qualified accountants and lawyers, said Adams. “You’ll need those relationships even if you know what you want,” he said.