Important considerations for real estate investors
Location. Favourable locations for commercial real estate are capital cities and regional centres. The locations of office buildings and retail properties should match the traffic routes of prospective clients. An investor should consider possible future outlook of a given location.
Liquidity. As opposed to residential real estate, in case of commercial real estate object the tenant risk is split among several counterparties operating at the property. While leases for residential properties are signed for up to a couple of years, commercial real estate leases are long-term, lasting generally 5-10 years. The process of selling commercial real estate normally takes longer compared to an average residential transaction, usually about half a year.
Projected return. The return (yield) on cash flow generating commercial real estate (e.g. office building with tenants) is 6-9 percent per year, while returns on residential real estate are generally in the range of 2-5 percent. Return on equity increases with leverage, but an investor should account for escalating business risks as well as loan and interest rate payment risks. While investing, an investor must consider macroeconomic environment that affects demand and rent level.
Net operating income. Net operating income is the revenue earned from a property (i.e. the stream of rental payments) less the owner’s expenditure on the property (management and administration costs, land tax, insurance, building improvements or the relevant reserve, regular maintenance of utility systems, security service, etc.).
Yield. When purchasing real estate, the yield rate is used – net operating income of the property divided by the acquisition cost of the property.
Financial instruments. Compared to residential real estate, the transaction size in case of commercial real estate is usually higher. There are several financial products on the market, such as real estate funds targeting commercial real estate properties and real estate-related bonds. Also, real estate projects are of interest to institutions representing various investor groups (family-office-type investment houses, real estate funds, crowdfunding platforms, etc.).