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While real estate offers plenty of opportunity for profitable investment, commercial real estate, in particular, offers several advantages for investors, including economies of scale, sizable cash flows, and substantial earning potential.
But with those advantages comes risk. Understanding how to evaluate a property’s investment potential and staying abreast of market trends are key components of successful commercial real estate investing. The old saying, “knowledge is power,” applies here, and the most successful commercial real estate investors are those willing to put in the time to monitor the market and arm themselves with accurate data and forecasts to understand how market shifts and trends can impact the return on investment.
The post-pandemic years have admittedly been a bit of a roller-coaster ride for the commercial real estate market.
There has been a decreased demand for office space due to employers and workers opting for remote or hybrid work situations permanently. While higher quality Class A properties with desirable features, a host of amenities, and long-term leases are less affected, Class B properties offering fewer frills and Class C space with very few features and rough finishes are likely to continue to struggle to stay profitable for investment.
According to analysts with J.P. Morgan, industrial properties, including warehouses and distribution, continue to perform well. The spike in e-commerce during the pandemic increased the demand for warehouse storage, although some analysts suggest the sector could be leveling out as inventory demand lessens. The sector remains strong despite some softening, according to Ermengarde Jabir, Senior Economist at Moody’s Analytics. Rent growth for this sector is expected to continue to perform about 5% to 6% per year above Moody’s Analytics commercial real estate 10-year forecast.
The pandemic accelerated growth for e-commerce, but with online shopping accounting for only 15% of all retail transactions, there’s still plenty of room to take advantage of brick-and-mortar retail property investment opportunities. However, the real story for retail investments may not lie with shopping malls, which have struggled in some areas.
According to a 2023 JLL report, mall vacancies have reached their highest levels in 15 years, as traditional indoor malls face increased competition from online shopping following the challenges of lockdown during the pandemic. Closures and bankruptcies have also challenged malls in recent years among so-called anchor stores, including JC Penney, Macy’s, and Nordstrom.
Instead, opportunities for retail growth may lie with neighborhood shopping centers, both urban and suburban. Overall, retail should continue to see steady performance, with no significant changes in vacancy rates and moderate rent growth.
For investors targeting multifamily housing properties, high mortgage rates are continuing to keep would-be home buyers on the sidelines and in need of rental options, buoying demand for multifamily housing and reducing vacancy rates.
While all eyes remain on the Federal Reserve, it’s important to remember the Fed doesn’t directly determine mortgage rates. However, its decisions have a significant impact on how mortgage rates move.
Rising mortgage rates are affecting residential home buyers as well as commercial real estate investors. Investors typically need to reinvest every few years and often face a lending industry that has significantly tightened its requirements. With this trend likely to continue through at least 2024, commercial real estate investors will continue to grapple with high interest rates and difficult-to-obtain loans.
The good news for commercial real estate investors is that there is a flip side to the coin when it comes to higher mortgage rates, at least for some sectors. Those same high mortgage rates that are making it more challenging for commercial real estate investors to finance their investments are also affecting would-be home buyers, prompting them to take a “wait-and-see” attitude toward their home-buying aspirations, leading to robust demand for residential rental homes, including triplexes, quads, and other multifamily housing, strengthening rents and putting downward pressure on vacancy rates with continued strong demand.
Another economic factor impacting commercial real estate investment is high inflation, which significantly increases the cost of everything from building materials to labor.
In addition, investors are facing the increased cost of insurance, which is already higher for commercial properties and is increasingly becoming less comprehensive and, in severe cases, unavailable. The uptick in natural disasters resulting in property damage has resulted in greater risk for carriers mitigating the risk to their bottom line through higher costs to the insured or less comprehensive coverage offerings.
Despite the risks, investing in commercial real estate can be a lucrative venture that can offset some of the more volatile pieces of an investment portfolio, such as the stock market. More than ever, real estate investors must stay alert to market and economic influences while looking for creative solutions to reduce costs and improve profits.
Technological advancements — specifically, artificial intelligence — can be used hand in hand with historical data already available to improve efficiency, reduce costs, and enhance decision-making, leading to stronger net profit.
AI can offer investors predictive modeling that could be a game changer. Analyzing a wide range of demographic data on everything from location and life-work trends to less obvious data, like transportation trends, can provide investors with forecasts for everything from supply and demand for specific properties to recommended rents.
By leveraging historical data, AI can also help commercial real estate investors make the all-important decision of identifying what real estate sectors will likely offer a good return and what opportunities warrant a pass. Using predictive modeling, investors can use AI to identify potential properties for acquisition and predate the best time for liquidation. However, predictive modeling is not the only way the power of AI can be harnessed for commercial real estate investment. It can be used to reconfigure or optimize space, which could lead to potential new income.
AI can also be used to automate maintenance requests, tenant communication, and other routine property management tasks, providing greater efficiency for owners and a better experience for tenants. Part of the improved experience for tenants could come in the form of generative AI, with chat-based expertise available as a value-added feature.
In addition to automating routine requests, AI can play a role in property maintenance by predicting likely equipment failures and environmental risks through building sensor data analysis. Instead of a reactionary role, property owners can anticipate issues, thus reducing the cost of repairs, avoiding property damage, and safeguarding assets from unexpected hazards.
While AI is useful, investors should not rely entirely on AI-generated recommendations. Instead, the technology is best used in conjunction with other methods to determine which opportunities are most likely to offer the best return on investment.
Commercial real estate investing is not without its risks. Yet, it offers the potential for some of the highest returns on property investments. The savvy real estate investor will mitigate their exposure by staying informed of market conditions and economic trends while also utilizing technology, particularly AI, to their advantage.
For investors with diversified portfolios, the challenge often becomes managing all investments efficiently and not getting overwhelmed with too many apps and spreadsheets, wasting time that could be used to build wealth.
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