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As an asset class, commercial real estate is often regarded as a high-quality investment vehicle that can generate excellent returns.
From office space to retail space and industrial buildings, investing in commercial real estate properties can provide investors with exposure to a variety of industries and asset classes. However, navigating the world of commercial real estate can be complex and intimidating, particularly for those new to the field.
This article explores how to make money with commercial real estate as an active and passive investor. We cover the most common methods for both types of investors to invest in commercial real estate and span all levels of involvement and effort—from ground-up development to passive REIT and ETF investing.
By reading this article, you should gain the foundational knowledge necessary to determine which opportunities might be best for you to enter or excel in the world of commercial real estate investing.
Let’s begin with how to make money as a passive commercial real estate investor, and then we’ll transition to how to make money as an active commercial real estate investor.
How to Make Money with Commercial Real Estate as a Passive Investor
Many investors like the idea of including real estate as an asset class within their total investment portfolio. However, many investors don’t like the idea of needing to manage challenges that inevitably arise from properties or tenants. In short, investing in a large, profitable apartment complex sounds great, but having to unclog a toilet at 3:00 am or track down a tenant who is late on rent sounds awful.
If you share this sentiment toward commercial real estate investing, being a passive investor is likely a great way for you to be involved. Passive investing offers the opportunity to invest in various commercial properties and create truly passive income without the need to be involved daily. Additionally, in today’s world, there are more ways than ever to invest in commercial real estate as a passive investor. Let’s look at the main ways.
Real Estate Syndications
A real estate syndication pools capital from multiple investors to purchase a larger property or portfolio of properties. An active investor (also known as a sponsor in a syndication), identifies a good investment opportunity and creates a plan to acquire, renovate, manage, and potentially sell the property. By creating this plan, the sponsor outlines how much money is required to successfully execute the plan and then creates a Private Placement Memorandum (PPM) to present the investment opportunity details. The PPM includes the investment structure, acquisition and renovation numbers, projected returns, and more.
With the PPM in place, the sponsor presents the opportunity to accredited investors (passive investors who meet certain financial criteria set by the federal government) to see who is interested in investing in the opportunity. When accredited investors decide to invest, they contribute their capital to the syndication entity and let the sponsor(s) manage the execution and management of the plan. Meanwhile, the accredited investor sits back and receives a regular check with an established return.
Syndications are one of the best ways accredited investors can generate passive income with good returns through commercial real estate. The reason is that because the accredited investor is working more or less directly with the sponsor, they’re more directly connected to the deal than investing in a publicly traded REIT where there are more layers and more people that need to be paid between the investor and the property operator.
If you’re not an accredited investor, though, don’t worry! There are other ways to invest in commercial real estate as a passive investor. Let’s explore them now.
Publicly-Traded REITs
Real estate investment trusts, or REITs, are a form of investment vehicle that hold and manage income-producing real estate assets such office buildings, malls, apartment complexes, and hotels.
An REIT is normally organized as a company, and anybody with access to a stock exchange and a brokerage account—which is often free to open with various brokers—can buy and sell shares in a REIT.
Publicly-traded REITs are regulated by the Securities and Exchange Commission (SEC), which requires them to meet certain requirements to maintain their status as an REIT. For example, a REIT is required to invest at least 75% of its total assets in real estate assets and cash, and derive at least 75% of its gross income from real estate related sources.
As a REIT collects income from the properties it owns, it distributes money to the shareholders through dividends, typically paid quarterly. By federal regulation, REITs must distribute at least 90% of their taxable income to shareholders. This allows investors to receive a steady stream of income, similar to owning a rental property, without needing to own a property themselves.
Publicly-traded REITs can invest in various types of real estate properties, including residential properties, apartments, office buildings, industrial properties, storage facilities, and hotels. Some REITs focus on a specific property type whereas others focus on allocating their funds toward multiple property types. With so many options available today, passive investors are empowered to diversify their REIT portfolio with the property types and geographic locations they want.
What makes REITs one of the most attractive ways to invest passively in commercial real estate is that they’re one of the most liquid methods of investing in real estate in the sense that if you no longer want the shares, you can sell them on any day you choose. This is fast and easy, unlike selling a physical property.
Private REITs
Private REITs are similar to publicly-traded REITs but have some key differences.
Like a publicly-traded REIT, a private REIT is a company that owns and manages a portfolio of real estate properties. However, unlike a publicly-traded REIT, a private REIT is not traded on a stock exchange and the shares are not available to the general public.
So how do you invest in a private REIT?
Private REITs are often made available to accredited investors or organizations, including pension funds and endowments, through private placement offers. The shares are less liquid, and the minimum investment amounts are sometimes larger than those for publicly listed REITs.
Private REITs are subject to state and federal securities laws even though they are not governed by the Securities and Exchange Commission (SEC). Before to investment, it is advisable to thoroughly read through the offering documents for private REITs since they contain additional laws and restrictions.
Real Estate Crowdfunding
Real estate crowdfunding can be viewed kind of like a hybrid between REITs and Syndications. Effectively, real estate crowdfunding enables investors to combine their funds using crowdfunding platforms or online financial technology (fintech) to finance real estate projects in exchange for a return on their capital investment.
The money pooled together from various investors on the fintech platform is then invested in Real Estate Investment Trusts (REITs) and other financial instruments that act as holding corporations for various real estate ventures. These properties might include homes, apartments, condominiums, shops, shopping centers, hotels, office buildings, and more. Nonetheless, investments made through crowdsourcing are often privately owned, unlike many publicly traded REITs.
Providers of crowdfunded real estate can give investors access to enticing private market assets that would not otherwise be offered to the general public. Moreover, they frequently provide larger returns than publicly-traded REITs, reflecting the potentially higher risk level involved with these investments.
The requirements to invest in a crowdfunding platform vary from platform to platform. Some crowdfunding platforms accept investments from all kinds of people with small minimum investments. Some require investors to be accredited investors, and others provide investment opportunities for both accredited and non-accredited investors. This element of variety is also true for crowdfunding platform offerings; some platforms allow you to select a specific property to invest in, whereas others offer a portfolio of properties.
Private Notes
Private notes are a more direct way to invest passively in commercial real estate.
Effectively, if a passive investor has liquid funds and knows an active investor who needs capital to fund a project, the passive investor can provide a loan to the active investor to fund the deal. To do this, the investors mutually create and sign a promissory note that outlines the loan’s conditions, including the interest rate, period, and repayment schedule.
When the loan is made, the active investor uses the funds to execute the project plan and pays back the passive investor based on the terms established in the promissory note. The passive investor often doesn’t directly participate in the project or the ongoing investment administration. All they do is lend money and earn interest on their investment.
ETFs & Mutual Funds
Aside from REITs, there are two other ways you can invest passively in commercial real estate via a stock exchange. These investment vehicles include Exchange Traded Funds (ETFs) and Mutual Funds.
Real estate mutual funds use experienced portfolio managers and thorough research to invest in multiple REITs and real estate operating businesses. Mutual funds provide passive investors with the opportunity to diversify their real estate exposure in a single, professionally managed investment.
Real estate ETFs invest their assets in equity REIT securities and related derivatives. REIT ETFs are passively managed (there isn’t a professional portfolio manager) and are based on an index of publicly listed real estate owners. The MSCI U.S. REIT Index and the Dow Jones U.S. REIT Index are two commonly used benchmarks that account for nearly two-thirds of the total market value of domestic, publicly listed REITs.
ETFs allow passive investors to invest in a diversified portfolio of real estate assets with lower costs since they are passively managed and track an index.
Both options can be good options for passive investors who want to keep their funds more liquid and gain exposure to larger portions of the real estate market.
How to Make Money with Commercial Real Estate as an Active Investor
While passive investing in commercial real estate is a great way to make money from commercial real estate, some people prefer to be hands-on in their real estate investing and are willing to put in the extra work in hopes of generating extra upside. If you want to be a hands-on investor, you’ll likely want to explore being an active investor through one or more of the following methods.
Real Estate Development
One of the most complex and hands-on ways to make money with commercial real estate is to become a commercial real estate developer.
Real estate developers make money by acquiring undeveloped land, building new properties, and then leasing or selling them for a profit. They can also purchase land with distressed properties on them, tear them down, and build new properties in place of the old.
One main benefit of development is that developers effectively purchase a building at cost regarding the raw land, materials, and labor costs. Once the building is complete, the final building is often valued at a higher price than the cost to build it, which is primarily where developers make their money when they decide to sell the property.
While development is appealing because of the way it generates money, it’s not for the faint of heart. Being a real estate developer requires you to deeply understand the needs of a market, secure properly zoned land or work with city officials to re-zone a piece of land, work with architects and a variety of specialists to design and properly build the building, manage unforeseen challenges that will arise throughout the build process, and more.
Real estate development may be for you if you thoroughly enjoy creating things from the ground up, don’t mind longer project timelines, and enjoy working with a diverse group of people and trades throughout the construction process.
Rental Income
The most common way that investors make money with commercial real estate is through rental income. To make money from a commercial real estate investment, investors must identify a property that can generate more rent (AKA revenue) than the expenses associated with owning and operating the property. The difference between the two (income and expenses) is called cash flow, and cash flow is what generates consistent income for investors.
Once an active investor has identified a property that can generate cash flow, they must get the money necessary to purchase and renovate (if needed) the property, increase rents, manage expenses, and manage tenants to continually generate cash flow.
After doing this for several years, the investor receives rental income, the tenants are also paying down the debt, and the property is likely increasing in value. As a result, when the investor decides to sell the property, they can also make money from debt paydown and property appreciation, which is the next way to make money through a commercial property investment.
Property Appreciation
A common saying in real estate investing is, “Don’t wait to buy real estate. Buy real estate, and then wait.”
The idea here is that, as mentioned in the rental income section, if you hold on to a property for a handful of years, the property is likely to increase in value so long as the local market increases in value. With this, another way real estate investors can make money with commercial real estate is to buy and hold commercial property, such as an apartment building, and then sell it after it has increased in value. The positive difference between the price an investor pays for a building and the price they sell it for is called appreciation.
What’s neat about a commercial property compared to a residential property is that commercial property is valued based on the income it produces, whereas residential property is valued based on comparable homes that were recently sold. This means that if you find a distressed investment property and renovate it to increase the rent, you can “force” appreciation. This is a big benefit of a commercial investment compared to residential rentals.
Additional Property Income
In addition to the more standard ways you can make money as an active real estate investor, you can also get creative and add additional income streams to a commercial real estate property. This can look different depending on what property types you focus on, but a few examples include adding shared laundry machines and storage units to apartment complexes or vending machines to strip malls.
These extra amenities can be small additions that generate great profit over time. As a result, savvy investors always do their due diligence and find creative ways to address the needs of their commercial tenants and create additional passive income.
Property Management
Some active investors choose to hire a third-party property management company to manage their properties. Other active investors choose to create their own property management company and use it as another way to make money with commercial real estate.
Property management companies are responsible for leasing units/properties, collecting rent, keeping tenants happy, responding to service calls, and taking care of the property among other responsibilities. Effectively, a property manager in the commercial space is responsible for ensuring the property operates smoothly, generates consistent income, and remains in good condition. It’s a very important job!
In exchange for these services, property management companies typically charge fees for management, leasing, maintenance and repairs, late payments, evictions, cleaning during turnover, and more.
By creating a separate property management company to manage their own properties, active real estate investors can make money from the investment property itself and the day-to-day management of the property while maintaining complete control over the entire asset and the way it is managed.
Summary
It’s possible to make money from commercial real estate in a variety of ways as a passive investor and an active investor.
When it comes to selecting which method(s) you want to use, there is no one-size-fits all solution. It all comes down to how much involvement you want, what type of return you’re looking for, and what type of property you want to be included or represented in your investment portfolio.
Take time to explore the methods that interest you most and be sure to talk with professionals as you decide on which method(s) to pursue. Additionally, if you’re just beginning your investing journey, be sure to read our complete guide to real estate investing for beginners.