Commercial real estate encompasses a large number of asset classes, including retail, office, mobile home park, RV park, apartments, billboards, industrial, self-storage and raw land. Each of these asset classes has their own unique characteristics. So how do you decide which asset class to invest in? With careful examination, you will rapidly see which niches hold the most promise, and which hold the least. Not all commercial real estate is created equal, and it is essential that you devote your time and money to the most profitable segments.
Highest Yields
Different assets classes have different average rates of return. At the current time, the highest-yielding forms of commercial real estate are mobile home parks, self-storage facilities, billboards and RV parks. These asset classes all trade for around a 10% cap rate or more. At the low end of the spectrum are apartments, retail, industrial and office, which trade at single-digit cap rates. Raw land, as it is non-income producing, has a 0% cap rate a(or even negative when you include insurance and property tax).
Diversification
The asset classes with the greatest portfolio diversity are those with the most number of tenants, namely mobile home parks, RV parks, billboards, apartment complexes and self-storage facilities. The riskiest niches are those with the fewest tenants, including retail, office and industrial.
Capital Calls
A capital call is when there is a substantial amount of extra money needed to repair or renovate a commercial property. These can run from virtually zero to gigantic sums. The asset classes that need little or no additional capital infusion after the initial purchase are mobile home parks, RV parks, billboards and self-storage. The niches that can require substantial sums for renovations and repairs are office, apartment, hotel and industrial – basically those niches that have large buildings that have to be maintained and upgraded over time.
Growth Prospects
Just as America is undergoing some unique shifts in its economy, so are the various commercial real estate classes evolving based on large trends and market forces. Giant catalysts such as the internet, the baby boomers, migration patterns, overseas outsourcing, changes in inventory control and the basic ways we live and shop, are having a profound effect on commercial real estate. The niches that have the best future right now appear to be mobile home parks (affordable housing demand trend), billboards (greater commutes), RV parks (19 million retiring baby boomers), self-storage (economic upheaval has caused even greater demand for storage), and apartments (dislocated homeowners are becoming renters). The niches that appear to be on the wrong side of the trends are retail (more consumers shopping on-line), hotel (on-line meetings are replacing face-to-face), industrial (more manufacturing being outsourced overseas and less inventory kept on hand), office (more employees working from home on-line) and raw land (less U.S. development)
Lower Down-Payment Requirements
The asset types that allow for entry with a reasonable amount of capital are mobile home parks, RV parks, and billboards. This is due to lower initial cost, as well as plentiful seller-financing from the owners. All other asset types require larger amounts of capital to invest in them, based on the size of the deal. As a general rule, you will need 25% to 30% down on most forms of commercial real estate – except those that have seller-financing, which can often range from 10% to 20% down.
Availability of Bank Debt
If leverage is a key component to commercial real estate, then the ability to find agreeable banks with reasonable terms are a big part of the puzzle. The niches with the greatest amount of available bank financing are mobile home parks, apartments, retail, office and self-storage. The most difficult niches to get a bank loan are billboards, RV parks and hotels. Raw land is nearly impossible, at this point, to find lending for.
Conclusion
Not all forms of commercial real estate are created equal. Although commercial real estate has been proven to be the most profitable form of investment, it is imperative that you be in the right niches of commercial real estate to do well. One of the first jobs of any real estate investor is to select the area in which they will specialize. The niche you choose will have huge implications on your performance, so select wisely.