Close this search box.

Commercial Property Insider

The Secret to Making [Profitable] Commercial Real Estate Investments

10 Minute Read

The way to become rich is to put all your eggs in one basket, then watch that basket.” – Andrew Carnegie

Commercial real estate remains one of the most reliable ways used by self-made millionaires to achieve financial freedom. However, with the potential for significant gain comes the risk of potential loss. 

This article will provide a comprehensive overview of what we believe are the secrets to making profitable commercial real estate investments. It all starts with an understanding of the factors below.  

1. Market volatility and types of risk

It is important to understand that there are specific reasons why investing in commercial estate is so difficult. One overarching concept, market volatility, can summarize it all. 

Volatility can be caused by factors like interest rate increases, changes in consumer preferences, and having an underperforming economy can cause reductions in property valuation. 

The secret to managing this volatility lies in staying informed of market conditions and being willing to adjust your strategy accordingly. See our article, “Who Else Wants to Understand the Real Estate Market?” for more information.

Similar to Darwin’s theory of evolution, those who are most willing to adapt to changing environments tend to survive rather than those who are the strongest.

A) Financing or interest rate risk 

Interest rates can impact market demand due to both the availability and affordability of financing. 

Even small increases in interest rates can have a profound impact on investment returns, cash flow, and the ability to meet debt service coverage ratios. This can impact a purchaser’s ability to buy a building and it can reduce an investments overall profitability. Please refer to our article, “The Ugly Truth About Interest Rates.

Maintaining positive long-term relationships with lenders and a positive credit rating can be valuable tools in securing favorable financing. Attractive rates can help reduce the total borrowing cost while concurrently increasing the likelihood of receiving funding.

Note: Commercial real estate investing typically has different lending criteria and a higher typical downpayment than residential investments.

B) Buyer- or tenant-related risk (vacancy risk) 

In commercial real estate, buyer- or tenant-related challenges, such as a change in the number of locations available or a drastic change in consumer preferences, are inherent risks.

Over supply can lead to increased vacancies and declining rents, under supply can drive up rental rates and increase the negotiating power of landlords. 

We recommend monitoring the supply-demand dynamics in your area to gauge the current position in the commercial real estate cycle. 

Consumer preferences evolve as technology and building construction trends change. For example, with the introduction of eCommerce, there has been a greater demand for properties with high ceilings to allow for more storage of materials. Building construction techniques have also improved over the past several decades, which can cause functional obsolescence of older buildings

Often, retaining existing tenants is more cost-effective than attracting new ones. To help maintain profitability and avoid the expenses associated with turnover, we suggest proactive tenant communication, addressing deferred maintenance concerns, and having rates reflective of the current market. A proactive approach of market rates can help you ensure you are charging adequate rents, and safeguard the value of your investment. 

After periods of extended vacancies, potential complications such as insolvency or bankruptcies can occur. (See our video,” How to Navigate Foreclosures and Receiverships” for more information.)

C) Property-Specific Risk 

The property-specific risk, as it relates to the condition of the building, is potentially the most costly and avoidable risk. With adequate due diligence, future costs due to related to deferred maintenance or environmental contamination can be identified, avoided or mitigated. 

In addition, a property’s location is unchanging, so it is one of the factors that you have some sort of control over in terms of predicting the quality of tenants, expected market rental rates due to the quality of the building, or factors such as vehicle or foot traffic.

To mitigate property specific risk, we suggest performing due diligence which can include getting a building inspection report done, engaging an environmental consultant, obtaining adequate building insurance and having an understanding of market rates. See our article, “Do You Make These 5 Mistakes When Selling Without An Agent?” for further details.

D) Market Risk

The broader economy is intricately connected to the commercial real estate market. 

When the economy is thriving, demand for commercial space often increases. Economic recessions can reduce consumer spending and business activity, causing a significant downturn in the commercial real estate market, even to the point of contributing to a market collapse.

How we evaluate the overall strength of the economy is by monitoring key economic indicators which provide insights into local and national economic trends that can impact the real estate market.

We suggest to start familiarizing yourself with the key indicators relevant to your market or subscribing to local government reports to understand economic trends such as net migration, GDP, or consumer confidence / spending. 

If you’re in the Edmonton market, see our Insights & Research page for the latest Quarterly Report. 

2. Choosing an Investment Strategy 

One of the most impressive skills that we’ve seen successful investors employ is the skill of financial analysis paired with intuition. 

These investors have the ability to analyze the financial performance of an investment, incorporate costs to improve a property, and, after they’ve established a baseline profitability or financial return criteria, they make a final discretionary judgment about whether or not to invest.

In other words, after establishing profitability, finding the right investment for you is very subjective. This is because it depends on their investment objectives and risk profile.

Investors typically utilize one of the following three investment strategies:

  • Risk-averse investors seeking long-term stability and steady cashflow typically favor a buy and hold strategy.
    It’s ideal for property owners who prioritize a predictable income stream and are patient enough to wait for property appreciation. Choose this strategy if you are comfortable with a more conservative, lower-risk approach, and if your financial goals align with a long-term wealth accumulation mindset.
  • The value-add strategy appeals to investors who are willing to take a more hands-on approach and actively improve existing properties to enhance their value.
    It combines both short-term potential gains through value enhancement and long-term wealth creation. If you have the expertise or resources to make property improvements and are looking for a balance between active involvement and long-term growth, consider this strategy.
  • Development and/or Speculation Strategies are often used by experienced investors who are at ease with market volatility and uncertainty. Individuals with high-risk and high-reward strategies often pursue this type of investment.
    The strategy is effectively betting on the future value of a property, with the belief that you are able to generate a value that exceeds the present-day costs. It is a risk vs rewards discussion. If you have a high-risk tolerance, in-depth market knowledge, and are seeking significant gains while being prepared to weather substantial losses, this strategy may be appropriate for you.
    Due to the potential downsides of this approach, it’s critical to thoroughly research the market and talk to industry experts such as real estate lawyers, accountants, and commercial real estate professionals before pursuing it.

To summarize: The investment strategy will depend on your financial objectives, risk tolerance, and often your available resources. 

3. Listening to the market

The commercial real estate market is known for short term volatility as it responds to various factors related to property demand and the overall state of the economy. As this demand fluctuates, adapting to any feedback the market provides is an important component of maintaining a profitable investment. See our article, “Who Else Wants to Understand the Real Estate Market?” for more information.

Periodically reassessing and adjusting rent rates to continue to be in line with market trends ensures that your rental rates are maximized and consistent with market rates.

Overpricing a property can lead to high vacancy rates because potential tenants may be deterred by a high monthly commitment, where underpricing can reduce your overall profitability or even the salability of an investment property in the future.

Lastly, make sure you collaborate with a skilled real estate tax accountant to take advantage of relevant tax deductions and tax planning that can lower your capital gains taxes.

4. Repositioning as needed

Even with the most prudent planning and diligence, there are still factors outside of our control. At City Commercial, in order to maintain profitability of an investment, we encourage our clients to establish more one exit strategy before they purchase a building. 

Repositioning by considering the following:

A) Exit Strategy

One of the biggest secrets to profitable commercial real estate investment is to recognize that selling a property is only one exit strategy. 

You can sell a portion of your building’s equity ownership, which will inject cash you may need to expand operations. 

This can take the form of a partnership, where you give up a portion of your equity in order to improve your cash position. This can also help you tap into others networks, providing additional market exposure, in addition to being a risk management technique.

If you have a property that you’ve owned for more than two years and you have significant equity in it, or if the value of your property has significantly increased since obtaining financing, you can refinance the building. 

This will result in higher returns and provide you with a capital injection, which you can then utilize to strengthen your financial position or reinvest in more commercial real estate! 

B) Contingency plan

As part of your planning, we suggest a capital reserve for any unexpected replacement costs, ongoing maintenance expenses, or longer-than-expected vacancies. This ensures that inevitable delays do not materially threaten an investment’s profitability.

Whenever possible, during prosperous economic times, focus on building a robust financial safety net. These reserves act as a buffer against financial uncertainties, helping to ensure the stability of your portfolio.

C) Creative short-term financing 

When owners experience a capital shortfall, as shared in our podcast, “Business Financing: Insights for Owners”, there are different forms of financing available to businesses to help smooth over a financial rough patch. 

This could include leveraging equity from existing properties or utilizing alternate forms of financing, such as getting a loan on receivables or obtaining operational loans, such as a line of credit. 

D) Selling may actually be a way to maintain profitability. 

There are a couple of situations where selling may be a viable option to consider to maintain profitability. 

You could be an investor facing a significant upcoming vacancy in your building. Alternatively, you might be an owner-operator that is not fully utilizing your real estate, and you are facing a negative cash flow drain due to expenses such as property taxes. If you can relate to this, please refer to our article, “Business Sales: How to Stop Avoiding It and Start Getting Clarity,” for further details.

If repositioning and selling a property is in your overall best interests as it helps you to meet your ultimate personal and financial objections and you are curious about what an agent or broker does, see our article “When Commercial Real Estate Agents Have to Sell a Property, What Do They Do?”.

5. Having the courage to take action

The concept of having the courage to take action and taking calculated risks encapsulates one of the most notable intangible factors we’ve seen in successful investors.

This is a perfect opportunity to share Theodore Roosevelt’s favorite quote with our founders.

“It is not the critic who counts, not the man who points out how the strong man stumbles or where the doer of deeds could have done them better.

The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood, who strives valiantly, who errs, who comes short again and again,

Because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions;

Who spends himself in a worthy cause;

Who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.

The secret to making profitable commercial real estate investments is thoroughly understanding market dynamics, analyzing investments ensuring they align with your investment strategies, being willing to adapt to the market, having contingencies, and most importantly, being prepared to have the courage to take action when opportunities arise.

About City Commercial:
We specialize in industrial real estate in Edmonton, Alberta, with the goal of one day serving business owners across Canada. If you need assistance in locating a skilled commercial real estate agent who can help you get wherever you are going faster, reach out to us. We’ll leverage our databases and knowledge to find a few of the best agents near you that we recommend.

Latest Insights

The harsh reality is that rising interest rates can significantly diminish the value of your commercial real estate and reduce your net worth.
Edmonton Industrial Market Report: Bank of Canada's 5.0% rates led to a Q1 sales volume drop. Properties under $4M saw sales down 40.2%, but $/SF up 18.4%.
Edmonton Industrial Market Report: A strengthened commercial real estate market is expected in 2024, with interest rates plateauing.

Compare Listings