Investing in commercial real estate can be daunting for beginners. This post explores commercial real estate basics, including financing methods, niches, and risk profiles.
Risk Profiles of Commercial Real Estate Investing
The following are the four main categories of a risk-reward payoff of commercial real estate investing.
Core investments are the least risky. They are stable and provide a steady cash flow. Most of these investments are Class A buildings that require little to no improvements when purchased and generate predictable cash flows. This is the way to go if you are looking for capital preservation overgrowth.
Core-plus investments are relatively stable since they are located in areas with financially stronger and responsible tenants. Their vacancy is relatively low, and they can access financing more easily.
This type of investment has more risk and may include refurbishing or renovation, which results in higher risk but higher returns.
These are properties with a current cash flow but may need more significant improvements. Such improvements can justify higher rates and finding ways to lower operating expenses.
They can provide more upside potential, but they may be riskier. This is because they use a higher leverage ratio compared to the previous two.
These investments offer the highest growth potential but have the most risk. They may need significant renovations and have high vacancy rates. An example of these investments is land.
Pros and Cons of Real Estate Investing
• Cash flow and appreciation
• No management obligations: You can hire property managers to maintain the properties on your behalf.
• Diversification: It gives you more diversification from assets like stocks and bonds. It can provide a higher ROI when other assets depreciate or inflation is high.
• Financial barriers. Real estate investments are not accessible to an average person. They are mostly open to accredited investors.
• Vacancies. Tenant vacancies can lead to continued pay for expenses with no tenants paying rent.
Consult a financial planner before investing to help you know what risk profile you can invest in. Also, take into consideration the pros and cons so that you can make an informed choice.