Overcoming the Challenge of Finding Profitable Deals in Commercial Real Estate
For a number of reasons, it is becoming more challenging to find profitable deals in commercial real estate. These reasons include; high demand, market saturation, fluctuating economic conditions and rising prices. This means investors are struggling to find opportunities lucrative enough to invest in.
However, there are solutions to this issue, and we will be looking more in depth at how and why these problems are present within the commercial real estate world and the solutions to help.
First of all, let’s take a look at why it is becoming more difficult for investors to find profitable deals:
Increased Competition: More and more investors (inspirational and individual) are flooding the market. This in turn means there is higher competition for the high-quality assets. This leads to price increases which limits profit margin.
Limited Supply of Prime Assets: Properties that are both good quality and in prime locations are beginning to become more and more scarce, which makes it difficult to find properties that have value potential.
Market Saturation: In major markets, property prices have soared. This reduces the amount of readily available deals that meet traditional profitability benchmarks.
Economic Uncertainty: Due to all the other problems that investors are seeing, economic uncertainty is very high. This is because of inflation, interest rate hikes and general concerns about an economic downturn cause underwriting future returns to become more challenging and this makes investors looking for long-term and stable deals feel insecure about putting money into a project that they may not benefit from.
Increased Regulatory Burden: Regulatory constraints, such as zoning laws, environmental requirements and taxation can also decrease the number of worthwhile investments.
These are all factors that are causing investors to look at other markets, asset classes and strategies. As well as doing this, they are still having to make sure that these deals meet their required return thresholds.
We are now going to look at the background of the CRE Market and what made it into what it is today:
For a long time, it has been a highly favoured asset class for generating consistent income. However, in recent years there have been come big changes which have affected it in a negative way.
- Price Appreciation: The more that money comes into CRE, the more there is an increase in property value. In cities which are popular when it comes to investing, the prices for office, industrial costs and retail properties prices are at the highest they have ever been. This reduces the amount of income that can be generated.
- Shifts in Demand: Due to the pandemic, people have started to use commercial spaces in a slightly different way, which has led to a higher level of demand for assets such as industrial and logistics centres. Traditional office spaces then face uncertainty. Retail spaces that rely on physical traffic have experienced a mixed level.
- Interest Rates: The increase in interest rates has led to expensive borrowing costs. This in turn squeezes profitability and can make it hard to close deals that are lucrative.
- Institutional Investment: Large institutional investors, such as pension funds and private equity, have increased their exposure to commercial real estate: this increases the competition for the highest quality properties.
- Secondary and Tertiary Markets: Core markets are now very expensive, which leads to investors looking to secondary and tertiary markets for value. While these markets can provide large amounts of money, they come with an increased risk due to lower demand, economic insecurity and often weaker infrastructure.
Understandably, these things have caused many investors to feel squeezed, where they are finding fewer deals that will provide strong returns.
While there are many big challenges when it comes to finding profitable commercial real estate deals, there are solutions where investors can use strategic approaches that use analysis, creative deal structuring and flexibility in asset selection.
These are some of the solutions that can be implemented to find profitable deals:
- Explore Emerging and Secondary Markets: With major urban markets becoming saturated, investors can look at smaller areas rather than big cities. By exploring secondary and emerging markets, you can find deals that may offer properties at lower prices, higher cap rates and more opportunity to find good value deals.
- Market Research: By looking at cities that are going through economic growth, population inflows or infrastructure improvements, investors can find profitable property.
Demographic Shifts: Meticulously analyse relevant demographic trends like migration of people and business from expensive areas to affordable regions. This can be an indicator of future demand for commercial spaces, making early investments profitable.
Local Expertise: Partnering with local brokers, developers or property managers can help you to familiarise yourself with those markets that you are unfamiliar with and find hidden gems.
- Focus on Value-Add Opportunities
Rather than buying stable and fully leased properties at market prices, investors should focus on opportunities that add value. They can improve the property that they buy and turn it into a higher value property and get high returns on their investment.
Renovation and Repositioning: Properties that come with a need for renovations, but are strong structurally, can offer high returns. After the property is renovated, investors can increase the price of rent and bring in higher-quality tenants.
Lease-Up Opportunities: Properties that have a high vacancy rate can be undervalued. Improving management and marketing can help investors to lease up the vacant space and boost Net Operating Income (NOI).
Operational Efficiency: Implementing better property management, reducing expenses or using technology can improve the efficiency of operations and boosts a property’s value without high financial outgoings.
- Creative Deal Structuring
In being creative with the structuring of deals, investors have a better chance of turning small opportunities into profitable investments. This includes favourable financing terms, joint ventures, or strategic partnerships.
Seller Financing: In some instances, sellers will be willing to provide financing at favourable terms which reduces the amount of equity that is initially required.
Partnerships: Collaborating with other investors, developers or operators can reduce individual risk and bring in expertise that may turn an average deal into a lucrative deal.
Long-Term Leases: Negotiating long-term leases with creditworthy tenants can give you stability and reduce the risk of vacancies, which helps you to bring in more money.
- Leverage Technology for Deal Sourcing
Technology plays a key role in investing, with digital platforms and big data analytics helping investors to discover profitable deals efficiently.
Deal Platforms: Platforms such as LoopNet, CoStar and Crexi enable investors to access a variety of properties within different markets.
Data-Driven Decisions: Big data analytics can provide insights into market trends, property performance, and risk factors. This helps investors make informed decisions. Machine learning algorithms identify undervalued properties that traditional methods could overlook.
AI and Predictive Analytics: By using predictive analytics, you can analyse future property performance based on a variety of things. These include tenant stability, economic trends, and local market demand.
- Reassess Investment Criteria
In the current climate, it could be useful to reassess traditional investment criteria and be flexible, by looking at opportunities that may previously have been overlooked.
Diversify Asset Classes: Consider diversifying into asset classes with a stronger demand, such as industrial, medical office or self-storage properties. They can offer higher returns at a reduced risk.
Adjust Return Expectations: Due to the increased competition, you should adjust your expectations of return, but still keep a disciplined investment approach. Look at long-term appreciation and tax benefits to include in the overall investment thesis.
While there are challenges present, you can operate in a strategic way to overcome them. Look at new markets, value-add opportunities, leveraging technology and be open minded in regard to creative deal structures. Thank you for reading, we this this has helped you. If you know anyone that could benefit from this, please share!
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