How Investors are Making Big Money on Commercial Real Estate

How Investors are Making Big Money on Commercial Real Estate

The search for alpha (i.e. returns) is what drives investors and when it comes to commercial real estate the race to reap profits is in full swing. For those who bought into the market during 2010 and 2011, making big money is relatively easy as valuations are working in their favor.

However, investors who made more recent purchases have needed to work a bit harder to achieve their returns. This doesn’t mean that they can’t make money investing in commercial real estate, it just means that they have a need to work smarter. With that in mind, here are some ways investors are making big money in commercial real estate.

Increased Occupancy Rates

This is the classic way for investors to make money and it doesn’t matter if they are offering office space for rent in Manhattan or in Topeka – without tenants the property is going to lose money. As such, developers are increasingly looking for ways to increase occupancy rates, even if it means slowing the pace of rent increases over the near-term.
The reason is simple, if a developer can attract long-term tenants (i.e. three years or longer) to its properties, then they will be in a better position to cash flow the investment. This will lead to a lower cost of capital and by extension higher returns.

Beyond this, developers are also looking at other ways to keep their occupancy rates high. These include offering short-term contracts for tenants who need overflow space as well as co-working spaces which rent for a premium per square foot when compared to traditional office space. Both approaches help to keep occupancy rates high while masking of rent increases on tenants.

Buy Low, Sell High

This simple rule of investment applies to almost every asset class – including commercial real estate. The premise is simple, find bargains and then ride the appreciation in value over time.

For some developers, this leads to a strategy of flipping properties as they acquire distressed properties, make minor improvement and then sell them for a profit. While other developers will take a long-term approach, especially in more developed markets, where they can use the appreciation in property values to take on additional leverage, which then could be used for capital improvements or additional acquisitions.

This strategy worked especially well when interest rates were low; however, recent moves by the Federal Reserve has begun to take their toll. This is especially true as the prime lending rate in the U.S. reached 5 percent for the first time since 2008. However, investing in commercial real estate is all about leverage and even as interest rates tick up, debt financing remains one of the best ways to turn 1 + 1 into five.

Non-Traditional Offerings

Investing in real estate today is more than just letting out office space. In fact, these days developers can make money from non-traditional offerings as they can from office rents. Among two of the most popular options include making space available for advertising and for base stations for cell networks.

While offering space for advertising is not a new way to monetize and investment in commercial real estate what has changed is itsimportance to the overall revenue stream of a property. In the past, it was often viewed as a marginal stream for a developer; however, new technologies and novel ways of communication have made it a more important source of revenue than ever before. The impact for developers is simple – with minimal investment, they can maximize their return.

In terms of cashing in on cell networks, this has become a proven strategy for property developers regardless of location. While some properties are better suited for cell towers, there is also the need to wire buildings for 4G and the coming 5G networks that will yield significant returns.

In addition, increased demand for cellular data is pushing wireless carriers to invest in micro-towers and this opens up the possibility for properties which might not have been viable in the past to cash in.

Everything as a Service

While the commercial real estate is inherently a service, developers have been slow to transition to a service mindset when crafting their offerings; but this is changing. Increasingly developers are turning to innovation in commercial real estate.

This could be via offering serviced offices at a premium or by converting office space into fitness clubs, dry cleaners, and even groceries. The goal is simple, maximize how much a tenant spends when they are on site and this will turn into big money for investors.

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