(FSB Magazine) -- The best time to buy commercial real estate, it seems, is always a few years ago. That's especially true today, with interest rates and inflation rising and consumer spending expected to sag.

But smart investors can still find regions and niches where prices are likely to hold up - especially entrepreneurs who know a downtown district well and can find buildings where a few improvements will increase the rent. Generally that requires imagination, effort, and money.

More from FSB Help wanted for HR firm A CEO and rodeo queen King of the mountain bike Current Issue

"It's a hands-on business," says Merritt Sher, principal of Metrovation (metrovationcapital.com), a real estate company that has flourished in markets ranging from Oakland to Red Bank, N.J. "If you're not creative, stay out."

Investors value commercial property by the profit it generates in rent each year, using a figure known as the capitalization rate. A million-dollar property netting $100,000 a year after expenses is said to have a cap rate of 10%. Big real-estate investment funds earned about 9% during much of the 1990s, but since 2000, the prices of commercial property have been bid up faster than rents, driving down returns. In 2005 the average cap rate for the U.S. was just 6%, the lowest it has been in decades.

In this kind of market, Sher suggests innovative strategies such as buying an old office building and converting it to apartments in a neighborhood that's attracting empty nesters from the suburbs. His firm has also offered low rents to startup retailers with cool products, knowing that their space requirements - and rent payments - are likely to expand in a few years. (Metrovation was an early advocate of Bed Bath & Beyond and gave the startup creative lease terms.)

Before you take the plunge, the experts have a few other tips:

• Look for cities with high occupancy rates for office and warehouse space, especially those that boast busy seaports and international airports. Cities such as Los Angeles, Miami, New York, San Diego, and Washington, D.C., are likely to see firm prices and rents. Beware of second-tier areas with few newcomers or chronic overbuilding, such as Atlanta, Baltimore, Dallas, and Philadelphia. Demand is declining for space in troubled Midwestern manufacturing hubs, including Cleveland, Detroit, Milwaukee, and Pittsburgh.

• Seek out shops, apartments, and offices in urban areas within walking distance of good rail or subway connections. They're attracting suburbanites fed up with traffic and fuel costs, downsizing empty nesters, and twentysomethings hungry for bright lights.

• Don't buy single-use properties that can't be converted. That empty Kmart may look like a bargain, but it's unlikely that another retailer will move in, and you can't chop it into smaller storefronts.

• Don't pay more than replacement cost for older properties. If a developer can erect a new building cheaper than your old one, she will.

• Demand a higher return on smaller, older, individual properties than you would from a big real estate investment trust. The REITs have lower borrowing costs, diversify among many properties and cities, generally own newer properties, and don't require you to call in a plumber to placate an angry tenant at midnight. REITs pay about 6% these days; if you crunch the numbers and expect to make anything less than 10%, Sher advises, keep looking.

------------------------------------------

Entrepreneurs profiting from real estate

Realtors: Home sales now a 'buyer's market'