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5 Considerations for Choosing an Investment Property
To help guide a thoughtful strategy towards investing in an income producing property, here are some of the most important considerations that an investor should keep in mind.
Image by Étienne Beauregard-Riverin via Unsplash
Commercial real estate is generally thought of as the golden goose of investment. Often touted as a market that can’t fail, many of the most successful investors have some form of commercial real estate properties within their portfolios. Owning an income-producing property isn’t just for veteran investors, of course. Commercial real estate, if approached correctly, can be a solid starting point for even newcomers to the investment world — so long as they qualify for financing.
Even so, while investment properties can be both exciting and impressively profitable, investing in real estate can be a daunting task for a first-time investor. Commercial real estate isn’t for investors with a day-trader mentality. Even discounting those factors outside an investor’s control, a potential investor must consider multiple facets of an investment opportunity before executing, as many things can significantly impact returns.
It is in that respect that it's important for potential investors to do comprehensive research before making an investment decision. To help guide a thoughtful strategy towards investing in an income producing property, here are some of the most important considerations that an investor should keep in mind.
1. Location
Everyone, by now, is probably tired of hearing the same old “location, location, location” schtick as soon as real estate investment is mentioned. But while it may seem like a stale bit of painfully obvious advice, the neighborhood that an income-producing property resides in largely determines the types of tenants the property will attract as well as the vacancy rate — which are factors essential to creating a good investment strategy.
For example, properties in college towns typically have a higher percentage of student tenants. While this roughly equates to a steady source of tenants, the inherent seasonality of school schedules could lead to seasonal vacancy issues.
2. Property Taxes
Uncle Sam will always get his cut. This is true regardless of whether an investor plans for it or not. Understanding the property tax situation in the area of a potential investment is an often underrated part of an investment strategy.
Property taxes are not a static figure across the board either — they can vary widely across a target market. Particularly in the case of comparing two or more possible acquisitions, investors will want to be aware of how much they will potentially be losing. That said, high property taxes are not necessarily a bad thing. Typically, high property taxes occur in more desirable neighborhoods — the types that commonly host Class A assets — though investors should be aware that many less-appealing areas also boast high taxes.
Either way, finding out what kind of taxation to expect is a relatively simple matter. The municipality's assessment office should have all relevant tax information on file. Conversely, it never hurts for potential investors to talk to the business owners and homeowners in the target community. This includes determining if property taxes are likely to increase in the near future. It isn’t uncommon for townships or municipalities facing financial hardships to raise taxes as the need arises.
3. Future Development
Future-forward thinking shouldn’t only apply to an investment property but to its surroundings as well. Keeping aware of current and potential growth in an area can greatly benefit investors. Visiting the municipal planning department can yield information on developments and project plans that have already been zoned into the area.
One important consideration is the amount of new construction in the area. Lots of new planned projects and those still in development typically represent an area of substantial growth. New housing means new potential tenants — or stiff competition, depending on the nature of the commercial property. Identifying future competitors alone can make a world of difference for an investment strategy.
4. Current Listings and Vacancies
A little sleuthing goes a long way when it comes to listings and vacancies. If an area has a high or growing number of listings, it could be attributed to a seasonal cycle — or a sign that the area is in decline. Either way, knowing can be extremely valuable. Then, there is also the matter of understanding the rent climate as well. High vacancy rates usually lead to lower rent demands in an effort to attract tenants while low vacancy rates typically pave the way for higher rents.
5. Rent
Rental income is a key contributor to an investment’s profitability, so it behooves investors to know the target area's average rental rates. Investors still deciding on the right property to acquire should make sure any property under consideration can collect enough rent to cover the expenses that go into an acquisition. A deep-dive analysis of the area should be done to gauge where rent prices may be headed in the foreseeable future. Predicting rent scenarios is by no means an easy or exact science, but entering a project with some decent insights as to how rent asks have performed historically can keep an investor ahead of the pack.
Final Thoughts
There is no one, single playbook for making all the right decisions when it comes to commercial real estate investment. Choosing an income-producing property takes significant research and strategy. There are amazing opportunities to be found across the country — spanning every asset class and metropolitan statistical area. Investors must be willing to put in the legwork and be mindful of all of the different components surrounding investment properties. Setting realistic expectations goes a long way, and these five key considerations should help keep your investment strategy anchored in reality.
Related Questions
What are the most important factors to consider when selecting an investment property?
The most important factors to consider when selecting an investment property are location, rental income, and the target area's average rental rates. Location is essential to creating a good investment strategy, as it largely determines the types of tenants the property will attract as well as the vacancy rate. Rental income is a key contributor to an investment’s profitability, so it is important to make sure any property under consideration can collect enough rent to cover the expenses that go into an acquisition. A deep-dive analysis of the area should be done to gauge where rent prices may be headed in the foreseeable future.
Sources: 5 Considerations for Choosing an Investment PropertyWhat are the benefits of investing in commercial real estate?
Investing in commercial real estate can offer a variety of tax benefits, such as accelerated depreciation, mortgage interest deductions, and reduced tax burdens for beneficiaries. For instance, if an investor buys a commercial property for $3 million, and its value increases to $4.5 million before the investor passes away, the investor’s beneficiaries will only need to pay taxes on the $1.5 million that the property has appreciated, not the entire $4.5 million sale price. This can save an investor’s heirs hundreds of thousands or even millions of dollars.
For more information, please visit www.commercialrealestate.loans/blog/the-top-10-tax-benefits-of-investing-in-commercial-real-estate.
What are the risks associated with investing in commercial real estate?
Commercial real estate is generally considered to be a higher-risk investment due to the potential for tenant default and the longer lease terms. Leasing velocity is much slower than in multifamily or single-family residential real estate, and so a vacant building may take longer to completely fill than a residential property.
Other risks associated with investing in commercial real estate include:
- Market volatility
- Interest rate fluctuations
- Inflation
- Changes in local economic conditions
- Changes in zoning laws
What are the tax implications of investing in commercial real estate?
Investing in commercial real estate can have a variety of tax implications. One of the first and most important things any commercial real estate investor should do is find a qualified tax professional who knows and understands the field. Working with a professional can help you reduce your levels of stress and use some of the best strategies when it comes to taxes and your property.
When it comes to taxes, you can deduct employee wages, independent contractor costs, and professional fees. This includes things like legal fees, property management fees, and accounting fees. Additionally, if you pay an independent contractor more than $600 in a single calendar year, you will have to send and file 1099s for them, since you qualify as a professional commercial real estate investor.
It is important to note that tax laws are constantly changing, so it is important to stay up to date with the latest changes and work with a qualified tax professional to ensure you are taking advantage of all the deductions available to you.
What types of financing options are available for commercial real estate investments?
There are several types of financing options available for commercial real estate investments. These include traditional bank loans, SBA loans, bridge loans, hard money loans, and debt fund loans.
Traditional bank loans are the most common type of financing for commercial real estate investments. These loans are typically offered by banks and other financial institutions and are secured by the property being purchased.
SBA loans are loans that are backed by the Small Business Administration. These loans are typically used to finance the purchase of commercial real estate and can be used for a variety of purposes, including the purchase of an existing business or the construction of a new building.
Bridge loans are short-term loans that are used to bridge the gap between the purchase of a property and the long-term financing. These loans are typically used when a borrower needs to purchase a property quickly and does not have the time to secure a traditional loan.
Hard money loans are loans that are provided by private lenders. These loans are typically used for short-term financing and are secured by the property being purchased.
Debt fund loans are a type of financing that is provided by private debt funds. Private debt funds are typically composed of a group of investors who provide financing to businesses and organizations in the form of loans. Loans from debt funds generally cover financing scenarios that many other lenders, like banks, may shy away from. This could include lease-up financing for multifamily properties, or a loan to rehabilitate an office asset.