The 5 Best Commercial Real Estate Investment Strategies
Episode Transcript
There are many different ways to invest in commercial real estate.
In fact, there are almost an unlimited amount of different ways you can invest depending on your asset type, property class, location, investment strategy, and so much more if you can get creative.
But finding the right investment strategy for you is very important.
Depending on your goals, you may choose to stick with one of the strategies we’ll talk about today or you could diversify by using several of these strategies.
Here are the 5 best commercial real estate investment strategies, according to yours truly:
The Commercial BRRRR
Development
Land Banking
Long-Term Buy and Hold
Owner-Occupied Real Estate
And each of these strategies is definitely worthy of having its own episode because we can really dive in and talk about the ins and outs of them for hours. So, I’m just going to give you a quick rundown of what each strategy is and how they’re done.
Let’s kick it off with my personal favorite, the commercial BRRRRR.
1. The Commercial BRRRR
The BRRRR method has been made super popular over the years by the team over at BiggerPockets.
This strategy is the one that I tend to lean toward whenever I’m evaluating one of my own investments.
BRRRR is also known as the “value-add” play and stands for:
Buy
Rehab
Rent
Refinance
Repeat
So B RR RR
The BRRRR strategy is very scalable and it can be used on single tenant retail buildings or downtown high-rises with hundreds of units and every type of property in between
So here’s how this strategy works.
First, You Buy An Undervalued Property
The key here is to find a property that is available for well below market rates.
There are many different reasons that a property could be available for less than market pricing - maybe you found an off-market deal and the seller just wants to move on, or the property could be in a distressed-seller situation where they need the money fast, but more likely than not, the property just needs a significant amount of value add - whether that be through rehab or repositioning with new tenants.
So, with all of that in mind, you’ll definitely want this investment at well below replacement costs. That will give you a little bit of cushion and certainly a nice spread for your profit margins.
After You’ve Purchased the Property, You Will Begin Your Renovation
Now - keep in mind - one big difference between residential and commercial is that you’re not renovating to the comps. You’re simply renovating to increase the perceived value to tenants so that they will pay you higher rents.
The most common renovations for commercial buildings include:
Interior and Exterior Paint
Updated Flooring
New Signage & Directories
New Lighting
I do just about every single one of these every time I acquire a new investment.
Again, while you may want to renovate above and beyond that, those few updates will make any building look brand new and are often enough, outside of anything structural or within your MEP (your mechanical, electrical, and plumbing), to justify rent increases.
Next, it’s time to Rent The Space To Tenants
Now that you’ve updated the look and feel of the building and brought new life to it, it’s time to fill it up with tenants.
If you have a background in commercial leasing, you’re already set here. You know exactly how to go about the process of finding tenants, negotiating commercial leases, and closing the deal.
However, if you haven’t leased commercial property before, I highly recommend that you lean on a leasing brokerage or property management company here. They can even get started recruiting tenants while you’re focused on renovating the building, which will hopefully give you a solid head start on leasing.
The quicker that you can lease out the space, the faster you can move on to the next step, which is:
Refinancing The Investment
This is the fun part. Well, all of it’s really fun, but this is where you get your money back.
That’s right - after you’ve renovated the building and leased it up, it’s time to pull all of your cash back out of the investment by refinancing the debt.
If you executed each of the earlier steps correctly, you should be able to refinance your investment based on a cap rate, which will allow you to pull all your initial capital out of the deal while still owning the building and receiving that cash flow.
Some banks will want to keep the loan and are willing to refinance at the new value once it’s stabilized, but you may need to find another lender. It’s best to know that on the front end so that your lender on the acquisition doesn’t charge you pre-payment penalties for replacing the debt.
Finally? Just Repeat The Process!
You’ve got your capital back. You’ve built up your balance sheet. And you still have cash flow coming in from a now stabilized asset.
Time to repeat the process again and work on building that portfolio of commercial real estate.
2. Next, we have Development
Development is one of the most creative and riskiest investment strategies in real estate.
When developing property, you may be creating a project completely from scratch from a raw piece of land or re-envisioning what already exists on the property - there’s quite a bit of that happening in the southeast now that you have all of these old shopping centers that no longer fill a need.
However, like I said, development is very risky.
While it probably has the highest potential to create insane amounts of wealth in real estate, it also has the highest potential for you to lose everything that you’ve worked for.
It’s critical that you understand what you’re doing and you definitely need to have the right team.
The first step in development is Buying The Dirt
There are many points of consideration when finding the ideal piece of land for your project, such as:
Location - obviously
Zoning - does the current zoning allow for the kind of project you’d like to develop?
Topography - how hilly is the site? It can get very expensive to move dirt.
Utilities - are there even utilities to the site or will you need to run them from the neighboring property? If so, again - that can get expensive
Traffic - will you be contributing more cars on the road than the infrastructure in the area can handle?
Demographics - are you delivering what the neighborhood even wants?
And, honestly, that’s a major oversimplification of what you need to really dig into and investigate.
Each of these pieces will determine not only if your project will be successful, but whether or not you can actually even develop the site in the first place. It may be impossible for you to achieve the zoning you’d like or your plans may just be cost-prohibitive.
Once you’ve found the dirt, it’s time to develop The Site
Now that you’ve found the ideal parcel that fits your criteria, it’s time to put your vision to work.
This is where having the right team becomes crucial because at this stage, you’ll be working closely with a civil engineer, an architecture firm, and your leasing or sales team so that you can fully plan out the project.
These advisors will help you determine:
The Development Feasibility
The Horizontal and Vertical Design, which is the proper site layout - what buildings should go where, how the utilities will run across the site
They’ll also help you put together Your Marketing Strategy
The most successful developers have a highly curated team of experts surrounding them, which allows them to better coordinate the many different aspects of real estate development because development is a massive undertaking and there are many different pieces to the puzzle.
So the sites under contract and you’re working on your plans. You also need to begin Securing a Construction And Development loan.
Commercial lenders want to see an outstanding track record when it comes to real estate development.
Especially considering how risky this venture is.
Which makes sense. Think about it - banks are not in the development or landholding business and they don’t want to have to step in halfway through a job to see it through completion if you go bankrupt. It’s just not what they do.
So, like I said, your team and strategy will be of the utmost importance here.
In addition to your engineers, architects, and leasing or sales team, lenders will review:
Your Operational Team
Your Financial Partners
And Your Project History
You definitely need to have an outstanding presentation put together for the lenders to review. This could be an offering memorandum if you raised capital for the project or essentially just a business plan and it will give your lender peace of mind and help them better understand your project and the intended outcome.
It’s also not a bad exercise for you, too, since it will help you put all of your thoughts on paper and bring it to life.
Now you’ve got the project underway and you’ll be Overseeing The Construction
Again, your team is here to help you oversee the construction of the site. You may not yet have the construction experience necessary to fully understand everything going on, but you do need to have a fairly high level view.
If this is your first project, you need to be onsite daily as work is underway so that you can ask any and all questions possible so that you can further understand the site work and construction portions of this.
Your architect is also there to make sure that the project is built to their design, so they should be in frequent contact with you and onsite, as well.
Doing so will ensure that the project is built to your standards and should help keep the project closer to its original development timeline, although I don’t know if I’ve ever seen a project delivered on time.
Choosing the right general contractor should also be very high on your priority list.
If your project runs into unexpected delays, cost overruns, or shoddy work, your pockets will take a major hit, and that can often fall directly on your contractor.
This GC will manage:
Horizontal Site Development (so moving dirt, placing all the utilities)
Vertical Site Development (which is what we call the bricks and sticks of the building)
And Interior Finishes and Warranties
Marketing And Completion
While under construction, your team should hit the ground running with a marketing plan.
Whether you’re leasing or selling these units, any and all pre-sales / pre-leases you can possibly get will significantly reduce your risk and, obviously, create momentum.
Activity breeds more activity when it comes to creating a successful project and if prospects don’t see much movement on the property, it could make them wonder why no one else is interested, so it’s very important to interview and hire the best leasing or sales team in your market that has a solid track record and understanding of your product type.
3. Our 3rd investment strategy is Land Banking
Land banking is the best strategy for the patient and hands-off investors out there.
Essentially you buy a piece of property in what you feel is the path of development and wait.
No late night maintenance calls. No building repairs. Very little work, which is what these investors find attractive about this strategy.
Your investment in the land is basically a bank account secured by the dirt.
As the development moves toward you, your property should increase in value and at that point, you can either sell it at the new higher value or, and this is a very creative way of doing real estate, you could partner with a developer to re-envision the property.
I’ve done this in the past where the landowner contributes the dirt as their equity share of the development deal, but they have no other financial obligations or risk outside of that. There are several different ways of structuring this partnership, and the landowner may or may not need to put the land up as collateral to the bank, so it definitely could be risky if you take that path.
So, the first step of landbanking is to find and Qualify The dirt
When you’re placing capital into a piece of property for this strategy, you need to be very careful and thoughtful about the parcel you choose.
Be sure that you understand how the zoning and planning works within that municipality, as that will determine whether your investment will be successful or not.
Review those documents to see how the city views the future of different districts, because if the city has future plans for that area where they intend to turn, let’s say farmland into a high density commercial district or maybe they’re going to run a major thoroughfare from the interstate, it could be an opportunity to land bank. But, on the opposite side of the coin, if the city sees the development moving in the opposite direction, you could find yourself with the wrong piece of land.
One of the most common points of consideration for landbankers is “should You Finance The Deal?”
Some investors will choose to place debt and leverage their land investments, but others simply choose to pay all cash.
The path you take is completely up to you.
But in my opinion, there’s certainly something to be said for owning a piece of dirt outright when it isn’t producing any income.
If you look back at 2008, many land bankers found themselves in trouble when they had to continue paying mortgage expenses, taxes, property insurance, and maintenance, all these costs of owning dirt that didn’t have any money coming through the doors.
However, if you can leverage and place the remaining capital into a different investment that will pay for your carry costs on this land, that could be a solid option. That’s just something you will want to seriously consider.
Until you sell the dirt, you will be responsible for Maintaining the Property
When land banking, you’ll certainly want to maintain the image of your land because you never know when your land will become valuable to someone else and image is everything.
So, be sure to keep the grass mowed, trash picked up, and remove any squatters on the property. That’s right - depending on your state, there may be squatters rights laws where if someone occupies your property long enough they have claim to it. I’ve never had to deal with this myself, but we did have to chase squatters off one of my grandfather’s properties multiple times so that we avoided this.
So, once you start to get interest in the property, you’ll definitely want to strike at that opportunity.
While waiting for the value to increase, you could also put together proposed plans for the development of the site.
These plans will help any brokers, developers, and visionaries see what could be placed on the site, which could make it more attractive and it could help really sell it as opposed to just leaving the dirt bare without any potential plans. Some people may not have the vision but they may want to buy your property from you and develop those plans.
4. The fourth strategy is Long-Term Buy And Hold
The long-term buy and hold has the most creative name on the list. Almost as creative as the name of this podcast.
With the long-term buy and hold you’re essentially buying an investment and holding it for the long-term. You could be holding for the cash flow or for the appreciation of the property or maybe if you get the right property you’ll get both.
You can utilize this investment method on any size and type of property from single-tenant net deals to skyscrapers.
There are also different reasons to invest in different types of buildings depending on how involved or uninvolved you want to be in the day to day operations.
First, You Determine What Type Of Property You’d Like Invest In
Obviously.
The beauty of this strategy is that it can be used on any kind of property, so whether you’re looking to buy Class A office space downtown at a 4.5% cap rate or a distressed, suburban shopping center with 52% vacancy, it could work.
Here are a few things that you’ll want to take into consideration, which will help you determine which properties you actually want to target:
Your Involvement - If you want to be more active and involved in the day to day, you may be able to achieve higher returns on your investment. Hopefully you do, since you’re taking on more work. However, this will limit you to only investing in your immediate area. If you’d like to take a more hands-off approach, you could invest in single-tenant absolute net properties pretty much anywhere in the country.
Your Risk Tolerance - Are you looking to aggressively grow your portfolio and your wealth? If so, you may be willing to take on more risk. If, on the other hand, you’re simply looking to maintain your wealth or you have a more conservative investment approach, you’ll probably want to place capital in a more stabilized asset.
Your Overall Goals - Do you intend to hold this property forever or will you be selling it at the first solid opportunity that flies by? You may take a different maintenance and leasing strategy for the investment if you’re going to hold this for the long term as opposed to if you plan to sell in the next 10 years.
Next, You Underwrite The Investment
You’re typically buying long-term hold investments for the cash flow they produce. Hopefully the property will appreciate in value, too, but that’s not your primary goal here.
So, it’s critical that you underwrite the investment properly and thoroughly examine any risks involved with the asset. So, review the leases that are already in place and consider:
The length of term (how long will they be there and how soon do you need to start finding the next tenant if they don’t want to stay)
The tenant’s credit (are they local, regional, or national? How many locations do they have?)
Rent increases (does the rent have annual increases or does it stay flat for the entire term?)
And any future vacancy (you want to prepare for that ahead of time so that you can minimize your vacant months)
If you’re unsure about how to underwrite a commercial real estate investment, there are software programs out there that you could use, including one that my team and I are planning to bring to market soon, you could work with a commercial real estate brokerage, or you could hire an underwriter to assist you through the process.
Underwriters typically charge around $1,000 on the low end and it increases from there - I’ve typically seen $3,000 to $5,000, but that underwriting is very important and crucial to your decision making, so it can be worth it.
Then, you manage the Ongoing Operations Of The Property
So, as the investor, unless you’re taking a very active role in the property, you likely won’t want to be involved in the day to day operations.
Especially if you intend to purchase more commercial property because your time is more valuable finding the next deal rather than dealing with HVAC issues for your tenants.
From day one, I highly recommend that you hire a property management company and a commercial leasing team (if necessary) to oversee the ongoing operations onsite. They’ll be your eyes and your ears and can really offload a significant burden from your shoulders.
Hiring an outstanding property management company can make all the difference with regards to:
Better Tenant Relations
Lower Vacancy Rates
They handle all of your financial reporting and work with your CPA on taxes
And they’ll also take care of any preventative maintenance or put out the fires that pop up
They’ll be working hand-in-hand with your leasing team to ensure that your investment performs at its absolute best, too.
And they’re incentivized to do that! The more rent they collect, the more they get paid. And, if this investment is successful, chances are good you’ll buy more and hand those over for them to oversee.
5. The fifth strategy, which you should definitely take advantage of at some point if you own a business, is Owner-Occupied investing.
Ever heard of “house hacking?” Owner-occupied commercial real estate is the exact same strategy. Except, for, you know, on commercial property.
You move your business into the property, you might lease other space to another tenant or two, and you basically use your business to help pay down the mortgage.
So, your business is helping you build personal investments.
When Choosing The Right Site, you will have special considerations that you wouldn’t have on another real estate investment.
If you decide to use this strategy, it’s important to find a building that also works for your business. Seems pretty straightforward, but I’ve seen people put the investment first and business second and it hasn’t really gone too well.
If your business can’t succeed or operate out of the property , you won’t have it for very long, anyway.
The mentality you should have for this strategy is almost a “business first, investment second” thought process.
These investments can be a multi-tenant situation or you could be in a standalone building - that’s totally your call and of course depends on the type of business you have.
Most investors that utilize this method like to have or prefer having at least one other tenant, in addition to their business, to help cover the costs of the building. Again - it’s like house hacking. You buy a duplex and live on one side while renting the other side to a tenant to help cover the costs.
You’re also able to get special financing.
Depending on how much of the building you plan on occupying, you could take advantage of owner-occupied financing, which gives you better terms than typical commercial loans, and for good reason.
The lender’s risk is considerably lower since your business is operating there, so you already have a rent-paying tenant and you’re less likely to abandon the investment since it’s tied to your business.
Depending on your lender’s requirements to qualify for an owner-occupied loan, your business may need to inhabit at least 51% of the rentable space, but I’ve seen some banks offer as low as 30% of the space.
You’ll find that interest rates are lower, down payments are lower, and you may even get a longer amortization period.
There are a few Special Considerations for owner-occupied investing.
When you owner-occupy your property, you’ll probably want to purchase the asset in a completely separate entity from your business.
Then, the entity that owns the property will lease space to your business.
Of course, you will need to consult with your CPA to see if doing this is advantageous for you before deciding which route to take, but there are many advantages to setting up the investment this way.
Your business still pays rent, which you can write off as a business expense on its taxes.
Those rent payments are then passed along to you as the owner as passive income, which is taxed at a lower rate.
And if you ever decide to sell your business, you could have a tenant in-hand with the new buyer because you could sign a long-term lease for that space before you sell, which gives you and the new owner peace of mind on the real estate side.
Outro
So that’s it for my 5 favorite commercial real estate investing strategies. I hope you found one that piqued your interest and if you ever have any questions, I’m always happy to help out - you can contact me through my website at TylerCauble.com, which will also be in the show notes.
Until next week - happy investing.
About Your Host:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors as a board member for the Real Estate Investors of Nashville.
Each week, I'm going live at 8:30am CST for my "office hours" to answer your questions about commercial real estate on the show. Let's hear what you'd like to know when it comes to brokerage, investment, and development!