November 2, 2012 Neil warshafsky

10 TIPS – Commercial & Residential Investing in Today’s Market

1. What are the market indicators to suggest now might be a good time to invest in commercial/non-residential properties?

The Ontario commercial real estate market has enjoyed a protracted period of positive sustained growth. This has been fueled primarily through a combination of low interest rates, higher rents, greater occupancies, low unemployment and a host of other positive factors.  Demand has spurred as a result of many influences such as: higher immigration, the consolidation of real estate ownership into fewer hands through syndication, securitization and other forms of corporate ownership, and concerns over alternative investments such as bonds and equities. Accordingly, with fewer properties trading coupled with greater demand, property values should continue to escalate. We are still on the up-slope of the current commercial real estate cycle.  A generous supply of fresh capital into the market mixed with a growing economy has served to foster an ideal time for investors to step into the commercial real estate market.

2. What are the different types of commercial properties and which type of investors would suit?

There are many types of commercial properties available to invest in. They include office, industrial, retail and multi-family buildings as the industry cornerstones. Also included would be hotels, nursing/retirement homes and other special purpose properties. Investor profiles would include a diverse range of individual investors, to insurance and other investment companies, trusts and other institutional ownership structures. The type of real estate investment and investor may be determined by the equity requirement, location, risk tolerance and a myriad of other factors.

3. What are the risks and rewards of each type?

Capitalization (“Cap”), rates (which is a measure of risk), differ depending on the type of property, the age, location, financial covenants, size, environmental and other concerns. Typically the lower the cap rate the safer the property is as an investment. Naturally, if a property is 100% leased to a national bank of a net basis the cap rate or yield would be much lower than if it is leased to an independent “Mom and Pop” type independent restaurant. There is a direct correlation between the risk and reward when it comes to commercial real estate investments. As an example, cap rates for multi-family or apartments are generally lower than those found for industrial properties.

4. What’s the difference of commercial and residential?

There are many differences between commercial and residential investing. The main difference lays the complexity, understanding and management skills required between the two. Commercial properties typically cost more on average than residential properties, so the barrier to entry is financially greater. It requires a better more comprehensive understanding of leases, physical repair matters, zoning, legislative concerns, taxation issues, financing and in general a greater knowledge of the issues which affect real estate. Residential ownership is a much simpler form of ownership. It is much more accessible due to the ease at buying a house or condominium.

5. Are commercial properties accessible to smaller investors? Why or why not?

Smaller investors may invest in and have access to commercial properties either directly using their own capital (such acquisitions will have disproportionately large expenses upfront), or indirectly through REIT’s, buying stock in public real estate companies, through real estate syndications and other forms of group ownership.

6. What kinds of things should smaller investors look out for when purchasing commercial real estate?

There are significant financial barriers to entry that will increase the cost of admission. Legal fees, environmental reports, physical assessments, appraisal costs, accounting fees, mortgage fees, management costs and other associated due diligence expenses will prevent the Buyer from receiving benefits from any economies of scale.  Many of these costs are not scalable and as such, may disproportionately increase the acquisition costs for a commercial property. These expenses will affect the acquisition cost base, and likely a carry forward burden, which may unduly affect the returns and ultimate profit on sale.

7. Does commercial real estate have the ability to give investors a good ROI? Why or why not?

Commercial real estate is a very viable and unique investment option. Investors can obtain very attractive ROI’s. The main variables which come into play include but are not limited to: location, location, location; nature and quality of tenants and length of lease term/s; physical condition of the property taking into account physical depreciation and issues surrounding the repair and updating of possibly outdated properties. In the end, ROI will ultimately be mostly affected by market conditions, length of ownership and interest rates.

8. Why do many smaller investors tend to stick more with residential properties instead of commercial ones?

Residential properties are somewhat easier to manage and understand. The tenants are residential occupants, so the laws, management issues and other related matters are fairly uniform. Commercial leases, tenant issues are more complicated and challenging. Issues such as complicated amortizations, chargebacks, exclusivity concerns and many other legal and managements concerns are the norm in commercial ownership. A commercial investor much have a much broader knowledge of real estate issues. Commercial properties are not as liquid as residential properties, so in the event of a disposition the process may not be as smooth.

9. Will hotter residential markets prevent potential investors from going the commercial route? Why or why not?

If the residential market get hotter it is likely that new less sophisticated investors will enter that market. Certainly investors will have a choice and some will remain and continue to invest in the residential marketplace. Commercial investors remain dedicated to their choice of investments. This investor is somewhat more sophisticated and knowledgeable. Many have experience through several real estate cycles and do not normally flip flop between

10. What is your forecast for Canada’s commercial real estate market?

In today’s National Post it was stated that the population within the GTA is expected to increase by $2.6M people by the year 2031! Assuming low interest rates remain low over the next few years, and demand remains high, along with the fact that commercial real estate is falling into fewer hands, the picture for the commercial real estate market remains very positive. There are fewer transactions, as investors are concerned over where they can re-invest, and many of the institutions and REIT’s do not re-sell their assets on a regular basis. It appears at least for the next several years that the demand will continue to outstrip the supply.