Recognise the benefits and drawbacks of making commercial real estate investments.
Any kind of real estate, whether residential or commercial, can present a profitable investment opportunity. Compared to residential properties like single-family homes or rental apartments, commercial properties usually offer higher financial returns, but they also carry a higher risk.
It’s critical to comprehend all of the benefits and drawbacks of investing in commercial real estate before making the best choice.
What is a Commercial Property?
Commercial properties might refer to:
“Mixed-use” buildings are those on which a variety of uses, including retail, offices, and residential space, are housed.
Benefits of Investing in Commercial Real Estate
The following are some advantages of purchasing commercial real estate as opposed to residential.
Income Potential – The earning potential of commercial rentals is the strongest argument in favour of making an investment. The yearly return on investment for commercial properties usually ranges from 6% to 12%, contingent upon the region, prevailing economic conditions, and extraneous variables (like a pandemic). That is a far larger range than single-family home properties typically experience, which range from 1% to 4% at most.
Professional Relationships – Small business owners typically want to safeguard their means of subsistence and take pride in their companies. Commercial property owners are typically LLCs that run the asset as a business rather than individual owners. As a result, interactions between the landlord and tenant are more like those of a business to business customer, which promotes civility and professionalism.
Public Eye on the Property – Retail tenants have a stake in keeping up their establishment because failing to do so will negatively impact their business. Because of this, the interests of commercial tenants and property owners coincide, assisting the owner in preserving and enhancing the property’s quality and, eventually, the return on their investment.
Limited Hours of Operation – Most businesses close for the evening. Stated differently, you work when they work. Apart from emergencies related to fire alarms or break-ins, you should be able to go to sleep without worrying about getting a call at midnight from a tenant requesting repairs or misplacing a key. It’s also more likely that commercial properties will have alarm monitoring services, which allow your alarm company to alert the appropriate authorities in the event of an emergency during the night.
Most Objective Price Evaluations – Compared to residential real estate, commercial real estate prices are frequently easier to assess since you can get the income statement of the current owner and use it as a guide for pricing. The asking price should be set at a price where an investor can earn the area’s prevailing cap rate for the type of commercial property they are looking at (retail, office, industrial, and so forth), if the seller is working with an experienced broker. Pricing for residential properties is frequently more subjective. Check out Assessing Cap Rate: Is that Residential Investment Property a Good Investment? for additional information on the topic.
Triple Net Leases – Triple net leases come in different forms, but their fundamental idea is that you, as the property owner, are exempt from paying property-related costs (just like you wouldn’t with residential real estate). All costs related to the property, including real estate taxes, are directly paid by the lessee. Your mortgage payment will be the only expense you incur. These kinds of leases are generally signed by corporations like Walgreens, CVS, and Starbucks because they want to keep their brand consistent and control those expenses. As an investor, this means you get one of the lowest maintenance income producers for your money. Triple nets are not often used with smaller businesses, and strip malls offer a variety of net lease options, However, these lease arrangements are ideal and are not available for residential properties.
More Flexibility in Lease Terms – Unlike the dozens of state laws that cover residential real estate, such as security deposit limits and termination rules, fewer consumer protection laws apply to commercial leases.
Cons of Purchasing Commercial Real Estate
Although investing in commercial real estate has many advantages over residential, there are drawbacks as well.
Time Commitment – In comparison to a residential investment, managing a commercial retail block with five or even a few tenants is more work. You cannot maximise your return on investment by being an absentee landlord. When it comes to commercial properties, you probably have to deal with a number of leases, yearly CAM adjustments (which are the tenants’ responsibility), additional maintenance issues, and public safety concerns. In a nutshell, you have more to manage; and just as your tenants have to worry about the public eye, you do as well.
Professional Help Required – If you are going to take care of maintenance problems at a commercial property as a do-it-yourselfer, you better have a licence. It’s likely that you won’t be equipped to handle maintenance problems on your own and that you’ll need to hire assistance for repairs and emergencies. Even though it’s not ideal, you’ll have to include this additional expense in your budget in order to properly maintain the property. When determining how much to pay for a commercial investment property, don’t forget to account for property management costs. The fees that property management companies charge for their services, which include lease administration, range from 5 to 10% of rent revenues. Determine in advance if you want to handle the relationships and leasing in-house or if you want to contract out those duties.
Bigger Initial Investment – It’s usually harder to get your foot in the door when buying a commercial property because it usually requires more money up front than buying a residential rental in the same area. After obtaining a commercial property, you should anticipate making some significant capital investments. After a few months of smooth sailing, your property may receive a $10,000 bill for roof repairs or a new furnace. More customers mean more facilities to maintain, which means higher expenses. It is your hope that the advantages of buying a commercial property over a residential one will be greater than the advantages of lower expenses.
More Risks – Commercial properties receive a higher volume of daily traffic from the general public, which increases the risk of accidents or property damage. Customers may be struck by cars in parking lots. These kinds of incidents can happen anywhere, but the likelihood of them happening increases when you invest in commercial real estate.
