The typical progression for real estate investors is to start with a single family home then move on to multifamily units, and some may finally make the leap to commercial real estate. Well, why not skip the trials and tribulations? Many of the seasoned investors say that if they knew what they know now when they first got started, they’d go straight to commercial.

Tom Wilson started out just like many of us. He relocated from Virginia to Silicon Valley, back before his employer Fairchild Semiconductor pioneered the integrated circuits technology to transform the region into the Silicon Valley we know today. His landlord at the time owned almost the entire street and that’s when he had his aha moment. Tom’s first investment was a $30K house that rented for $300. Soon enough, to achieve better returns and efficiency Tom finds himself exchanging his investments out of California but into places like Dallas-Fort Worth area to now today transacted over $500M worth of real estate in his 5 decades of investing.

Why don’t people invest in commercial real estate?

Commercial real estate definitely has its hurdles. First is the large sales price. About the same amount of value is transacted each year in residential vs commercial real estate. The difference is that instead of the average $200K transaction value for residential, you’re talking about $20M for commercial, so it’s not something someone can just jump in willy nilly. Second is the lack of knowledge. What does cap rate mean? How about NOI, NNN, CAM fee, TI allowance? You can definitely learn what these things mean but you could also shoot yourself in the foot if you are not sure what’s in the contract. Lastly, is the management. You will need professional management to help you market and maintain the properties.

Benefits of commercial real estate

For those that took the time to educate themselves, found a good team in place, and maybe pooled other investors together, commercial real estate has some very distinct advantages over other investment strategies and asset classes:

NNN – Remember all the expenses you’d have to pay as landlord such as insurance, property tax, maintenance etc? Those are your tenant’s responsibility now under a triple net lease. Lower expenses = higher returns.

Better tenants – Instead of Joe Schmoe paying you rent, commercial tenants are often high quality tenants or even Fortune 500 companies and they guarantee the lease. Do you think they’ll have a problem paying rent unless something extraordinary happen with the economy or some kind of black swan event? No.

Longer leases – These commercial tenants want to run their businesses in a predictable fashion. They often sign long term 5, 10, or even 30 year leases. This leads to more predictable cash flow for the investor with renewal options and annual rent increases built in already. You don’t even have to worry about rent control.

Value-add opportunities – Commercial properties are valued differently than single family homes. They use prevailing market cap rates instead of comparable sales. Meaning if you increase the rent $100 or saved $100 expense a month, your property’s go up by the corresponding cap rate. For example, 7.5% cap rate means the value went up $16,000 or 5% cap rate at $24,000.

Economies of scale – Commercial real estate is simply more efficient. Instead of having tons of overhead, you just need one on-site manager, one loan, one property, one insurance, and one roof to manage.

Criteria for evaluating commercial real estate deals

Evaluating commercial real estate deals is not that different from traditional residential. Your tenants are often businesses instead of individuals. You’ll want to look at the following:

  • Cap rate – how does it size up to its relative market, asset class, region, and tenant quality. You have multifamily, retail, office or industrial. Within each there’s different subsets as well.
  • Cash flow
  • High population growth
  • High employment growth
  • Team – must have good management
Why syndication?

Syndication is a great investment vehicle. We often don’t know about it because it’s not advertised through these big investment firms like Fidelity or Charles Schwab. If you are able to find operators with a good track record that operate with integrity and with the investors’ interest in mind these investments can deliver above market average returns.

Smaller investment – Instead of putting down millions yourself as down payment, many the minimum investment amount is $50k. Some younger syndicators might do $25k.

Leverage the sponsors – This includes their access to deals, credit, and management team.

Diversification – The market is made up of thousands of submarkets and there is always a bull market somewhere. Instead of traveling to find and manage it yourself, syndication can provide you access to asset class and geographical areas that are strong you normally wouldn’t be able to tap into on your own.

If you’re interested in learning more, Tom was recently on the Real Estate Guys Podcast. He has a white paper out on commercial real estate as well, and you can get a copy of the presentation on Wilson Investment Properties as well.

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