Having a written investment plan is an important part of commercial real estate investing. With a solid plan, you can make sure each new acquisition plays a strategic role in reaching your goals.
By establishing your goals upfront, you're more likely to meet them and less likely to stray from your plan. But what goes into a commercial real estate investment plan? Here are seven things to think about.
1. Determine your niche and diversification strategy
Research the types of investment property, including multifamily residential, office, retail, and industrial properties. You can even invest in land.
Once you know more about what's available, you can start to make a plan. Do you want to own some of each, or develop a niche in one? There are pros and cons to both strategies.
It's hard to become an expert in each asset class. On the other hand, buying into multiple asset classes protects your portfolio from downturns in a single type. If manufacturing takes a hit during a recession and you own only warehouses, you could be in trouble.
2. Pick a few geographic areas
Just like it’s hard to become an expert in multiple asset classes, it’s tough to become an expert in many different markets. Picking just a few target markets for your commercial real estate investment business improves your chances of success because it diversifies your risk while allowing you to learn a few markets very well.
You’ll go into your acquisitions with eyes wide open about what you can expect and how to run your business, especially if you know there is a high crime rate, in-demand school district, or another factor that can influence supply and demand for the property. This could determine the number of resources you dedicate to it, such as hiring a third-party manager.
3. Set a target holding period
Real estate is a long-term game, so you should expect to hold properties for at least 10 years. If that’s not your plan, lay out why in writing.
Say you’ve built your acquisition and management plan around selling in five years. What will you do if the property doesn’t meet your goals at that time or if you can’t sell it? How and why did you come to that target holding period?
Thinking about timelines can guide your purchase decisions, especially if the properties you’re interested in are in up-and-coming areas.
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4. Establish realistic return-on-investment goals
Before buying your first property, learn the definitions of capitalization rate, internal rate of return, cash-on-cash return, and net operating income. Set reasonable targets for these metrics based on your market and asset class and try not to stray from them.
These targets should be fairly accurate and achievable if you’ve researched rents, prices, and operating expenses in your target areas.
If a property doesn’t meet your targets, you may want to take a pass so you can jump on one that does when the opportunity arises. Knowing your numbers and performing due diligence helps you make the best use of your available investment dollars. That's one of the keys to achieving the goals and objectives you laid out at the beginning of the process.
5. Develop a growth strategy
How will you grow your commercial real estate investment business? Will you start with one property that you can continue to trade up in 1031 exchanges? Or will you use the cash flow from the first property for other investment opportunities, acquiring more as you go along?
Having an idea of how you'll grow can help guide your purchase and sale decisions. Let's say you buy a property that costs $100,000 and earns you $500 per month. Ten years later, it has appreciated to $200,000. You want to manage fewer properties but increase your income, so you sell the property and use your $100,000 profit to purchase a $300,000 property that earns $1,000 per month. Ten years later, it’s worth $400,000, and you have $200,000 in equity. The area has appreciated so rapidly that you can’t buy anything outright with your $200,000, so you plunk it down on a $600,000 property that earns $2,000 per month.
Continuing with a growth strategy like this helps you make big gains in real estate.
6. Make a plan for networking
Having a networking plan is key to growing your real estate investment business. Start meeting and talking to other investors sooner rather than later. You can learn from them and share resources and opportunities. Many commercial real estate investment deals are between people who know and trust each other.
You’ll want to network with other professionals so you can engage a good accountant, a couple of private and bank lenders, real estate attorneys, and commercial sales brokers before you need them. That way, when an opportunity arises, you can get things done quickly.
Let’s say an investor friend comes to you with a proposal to form a partnership to purchase a six-unit apartment building. He’s got it under contract already with an agreement to close in 60 days. You’ll want to have a lawyer you trust at the ready to review your partnership agreement and possibly a lender so you can close in time while still protecting your own interests.
7. Create a sub-business plan for each property
Whenever you plan to make a new acquisition, do a mini business plan for it and address all the above points. How will this property help and complement your overall business?
What are the pros and cons of its location? Does it meet your target for return on investment? Do you have the bandwidth to take it on right now? Do you need to take on partners to make the deal work?
Doing this has two benefits. First, you set a clear roadmap that can guide your decisions about this property. Second, you can use that plan to approach lenders and partners with a clear understanding of the property’s value proposition and how it fits into your plan.
Take the time to plan in advance
When starting any new endeavor, it’s best to plan twice and execute once. While you’re going to be learning and growing as you acquire, manage, and optimize each new property, you’re also likely to experience a few headaches and challenges.
These will be better mitigated and remedied if you have a plan to refer back to. And it'll remind you of why you’re in the commercial real estate investing business in the first place.