Is Commercial Real Estate the Right Investment for You?
For centuries, real estate has been one of the premier investment vehicles in the world and has made many people vastly wealthy. Commercial real estate includes property for commercial purposes such as office buildings, warehouses, storage units, retail complexes, e.t.c.
Commercial real estate investing differs from residential real estate and requires different skills and attitudes. If you decide to become a real estate investor, you must choose whether to invest in commercial or residential real estate.
It is difficult to know whether commercial real estate is a suitable investment for you. The following are points to help you decide:
Most investors choose commercial real estate over residential real estate because of the earning potential. The returns you gain from the commercial property will depend on factors such as the location, economic factors, space & size, zoning issues, e.t.c.
Commercial properties historically earn higher average annual cash flow and return on investment (ROI) than residential properties. The average annual returns of commercial properties are three times higher than those of residential properties.
Therefore, if you want to invest in properties that will give you more cash flow and better returns in the long run, commercial real estate investment might be the right choice for you.
As a commercial real estate investor, your tenants are businesses. Because business owners want to protect their source of livelihood, they often put more effort into developing a relationship with the property owner or manager.
Moreover, owners of commercial properties are often companies, not individuals, making it a business relationship that differs from a residential property landlord and tenant.
The relationship between tenant and landlord is more of a business-to-customer relationship which helps keep interactions professional. Keeping the relationship professional will have better results than making it personal if you are a new landlord of a commercial rental property.
Because of the professional relationship between commercial property owners and their tenants, commercial properties tend to have higher quality tenants than residential properties. A commercial property's tenants are businesses with a vested interest in maintaining the relationship so they remain profitable. Commercial tenants also want to maintain a professional public image which means they are more likely to take care of and maintain the property to protect their business and brand. When both parties' interests are aligned, the relationship between tenant and landlord is better as both are interested in enhancing the commercial property's value.
Limited Operational Hours
Commercial property is a business, and like other businesses, there are hours of operation. There are no operation hours in a residential property as the tenants need to access and use the property at all times, which makes managing them very difficult.
Contrarily, when you own a commercial property, you are sure of the operating hours of your tenants, making property management easy. For example, it is easy to clean commercial property or do repairs because the work can be done at night when most of the tenants have gone home.
Unless it is an emergency, for example, a break-in or a fire, you can rest assured that your property is fine and you will not receive a call from a tenant.
Professional Property Management
Commercial property is often a better investment option than residential properties because you will get professional property management. Commercial properties make more money than residential properties, and because of the professional relationship between tenant and landlord, professional property management services are often necessary.
For example, property managers will use sophisticated tools like commercial real estate software from Northspyre to manage a property. On the other hand, a residential property owner will often employ a caretaker to handle the property.
The caretaker will then handle repairs, cleaning, and maintenance to others less professionally than commercial properties. The main benefit of professional property management is better results, and you can hold the manager accountable in case anything goes wrong.
Another reason commercial real estate investments might be suitable for you is that they receive significant tax benefits from the authorities, which significantly influences your investment returns. These benefits may include mortgage interest rate deductions, lower depreciation rates, and deductions for non-mortgage expenses like maintenance, renovation, and association fees.
1031 exchanges can help commercial property owners avoid capital gains tax when they sell the property or reinvest the gains into another property or asset. To become a commercial real estate investor, you should consult a tax professional to discover the tax benefits you can gain from your investment.
Objective Price Evaluations
You will likely get more objective price evaluations with commercial real estate than residential real estate. As a commercial real estate investor, you can get a property's current owner's income statement to determine the property's value as you do when determining the value of a business.
Commercial real estate buyers will expect to earn the same rate of return as the current owner, who sets the price depending on the type of real estate, e.g., retail, warehouse, office, e.t.c.
On the other hand, residential real estate pricing is often subject to emotions as homeowners are emotionally connected to the property. The asking price will hence often not reflect the actual price of the property.
Triple Net Leases
Triple net releases are different, but the basic concept is that the property owner does not pay expenses on the property, as is the case with residential real estate. The property's lessee pays for all the expenses directly, including property taxes. Other expenses the lessee pays are insurance and property maintenance costs.
Therefore, the property owner is only responsible for paying the mortgage. Therefore, as a commercial real estate investor, you have one of the lowest maintenance, income-generating assets.
Moreover, commercial leases are often two to ten years long as opposed to six months to a year for residential properties. Therefore, you get fewer vacancies and turnover with commercial properties so triple net leases are ideal.
Large Initial Investment
A drawback of commercial real estate investment is that they require a substantial amount of capital upfront because of their high prices based on high earning potential. Therefore, getting your foot in the door is challenging because you need so much.
It is not for you if you cannot find a loan or investors for a commercial real estate project. The maintenance and upkeep costs make up a significant part of the investment's working capital which are also large capital expenditures. Therefore, if you want to invest in real estate, you should consider where you will get the money.
Professional Help Necessary
It is impossible to manage a commercial property yourself so you will require professional property management services to run it. The more properties you have, the more help you need to manage them and the more public safety concerns you have.
Therefore, you should always consider the property management expenses when determining the price to pay for a commercial property. It is always better to outsource property management services, but it will cost you about 10% of your earnings. Commercial property investment is not for you if you are not ready to pay property management fees.
Commercial real estate requires more time than residential properties, particularly if you manage the property. If you want to maximize your commercial property investment returns, you cannot be an absentee landlord.
You will be dealing with multiple leases from tenants using the space at full capacity. If anything goes wrong, you must promptly fix it, or clients risk losing money. Moreover, a commercial property's maintenance and public safety issues can be significant.
Therefore, if you are unwilling to commit the time to manage the property, hire a property manager or do not invest in commercial real estate.
When investing in commercial real estate, you must consider zoning issues. Commercial zoning has many categories; hence zoning regulations tend to be more complex and have more requirements than residential real estate.
You need to understand zoning issues as a commercial real estate investor, which means more education to be compliant and avoid issues with local authorities.
The public has access to commercial properties which means they are exposed to more risks than residential properties. Only the owner can invite people into a residential house, meaning less risk of theft, vandalism, and damage.
On the other hand, the many public visitors on a commercial property significantly increase the chances of slip and fall injuries, public health concerns, and property damage, among others. You may have to address these risks and sometimes pay for them if you lose a lawsuit. If you are risk averse, commercial property will not suit you.
When becoming a commercial real estate investor, there is much to consider, including returns, professional relationships, tenant quality, initial investment, tax benefits, operational hours, risks, and more.
You can only know if commercial real estate investing is right for you by evaluating the above factors. The high risk/ high reward character of commercial real estate investing is not for everyone, and you should ensure it is right for you before putting a dollar into commercial real estate.