What you Need to Know about Commercial Real Estate Investing

One topic always on-trend is real estate investing.  Why?  With home improvement shows, buy-and-sell features, newsfeeds about the hot local real estate market – no wonder people want to get in on the action.

Many investors look to residential properties to help improve their investment portfolios.  But perhaps it is time to think about commercial real estate investing and see if it’s the right investment for you.

To help you understand commercial real estate, let’s define it.

Definition

Simply put, commercial real estate includes any type of real estate not considered home ownership.  What about that five-storey apartment building in your neighbourhood?  Yes.  What about the corner plaza with the gas station?  Yes.  Commercial real estate includes all those things and more.

Commercial real estate has four primary asset classes:  office space, industrial, multi-residential properties and retail.

Income-Generating

Thinking about these four types of properties, one thing stands out:  They all have the potential to create returns through three sources:  consistent cash flows from operations; increases in equity from mortgage principle repayment (in a sense the tenants buy the building for you); and, increases in property value over time.

Favourable Investment Returns

Income-producing commercial real estate has also historically generated favourable absolute and relative total returns.  For more than 30 years, the four primary classes of Canadian Commercial Properties have generated average annual returns ranging from 8.6 % to 10.6 %.  All four classes also outperformed Canadian Bonds.

Source: 1a,b,c,d,3 – MSCI Inc., 2 – Morningstar

Downside Protection

Even though commercial real estate investing may require larger amounts of financial support, it is a secure investment choice and has downside protection.  From 1988 to the end of 2019, multi-residential properties and retail properties never had a negative annual return.  Industrial and office properties have had only three and five years of negative returns, respectively.  In contrast, Canadian Bonds, US Equities, Global Equities, Canadian Equities, and Emerging Market Equities had negative annual returns:  9%, 19%, 22%, 25% and 31% of the times, respectively.

Source: 1 a,b,c,d,3,5,6 – MSCI Inc., 2  -Morningstar, 4 – Bloomberg

Lending and Development

Commercial real estate investing sounds good so far.  Two more interesting ways to invest in commercial real estate are lending and development.  Usually reserved for the more informed and sophisticated investor, these two categories provide another investment vehicle for commercial real estate.

For one, lending – or debt-focused investments – has the potential to provide consistent cash distributions and capital preservation.  Debt and mortgages maintain a high capital priority and have a claim on non-secured assets while being directly backed by the underlying property.

Real estate development, on the other hand, may require an investor to tie up their investment for the length of the development.  This investment doesn’t pay regular distributions to their investors because a return is not paid until the project is completed, which can take years, but you can be rewarded for that patience.

Commercial real estate is different than investing in home ownership.  An investor should therefore consider the different types of categories to find one that aligns with their timeline, appetite for risk and expected return on investment.