If you are a residential real estate investor looking to branch out, commercial real estate is the next logical step to expanding your business. But like every new endeavor, commercial real estate investing comes with its own risks and rewards.
Real estate investing has all sorts of different niches an investor can find themselves in. These niches are great places to hone your skills and build up your business. But when you want to expand outside of your comfort zone you need to assess the benefits and the drawbacks and how it compares to what you are used to.
Commercial real estate is a popular area of investment. Like residential real estate, commercial real estate is a broad term, an umbrella that covers an array of smaller more specialized areas of investment. There are generally around five different types of commercial property with additional subtypes that specify the type of property even further. But even if you are looking to invest in office space rather than retail space the pros and cons of commercial real estate investment remain mostly the same.
The most important thing you can do for your existing business is to make sure you are making educated moves when you are expanding to new territory. Knowing the common issues and planning for them in advance is the best way to ensure that your business will not only survive, but thrive in your new area of investment.
The Pros of Commercial Real Estate
There is a reason why commercial real estate is a popular area of investment. If you have the experience or are willing to put in the time and effort you could have profitable, long lasting investments that pay off year after year.
Getting involved in commercial real estate is not possible for every investor but it can be the venture that greatly accelerates your investing business.
The income potential of commercial real estate is often much higher than residential properties. Even with a property in a not so competitive area commercial rates can still outpace residential rates significantly. One of the reasons investors get involved in commercial property is because of the high income potential. If the space is in good condition and well maintained the yearly profits could be significant. If a property is in a competitive area the income potential could be even more significant. Either way if you have a commercial space that is regularly occupied, you will see high profits.
Additionally many commercial properties are arranged with a triple net lease, which means that the tenant will be responsible for all of the property expenses including maintenance costs as well as real estate taxes. This kind of lease arrangement decreases costs significantly on the property owner and can contribute to higher profits. This is not something that is available with a residential property.
More Favorable Lease Terms
One of the biggest issues when owning any kind of rental property is the constant turnover of tenants and the lease terms you must meet. When a one or two year lease ends on a residential property the owner needs to go out and advertise to find a new tenant. Having to do that every year is costly and increases the time the property is vacant. The owner also has to do constant maintenance and upgrade appliances to keep the property up to date.
For commercial properties the leases tend to be much longer and the requirements are much more flexible. It is not uncommon for a commercial lease to last a decade or more. That stability makes managing a commercial property much easier and more consistent. Imagine having the same tenant for 10 years? That would make managing a property much easier.
There is also a lot more flexibility with commercial leases because you don’t have to meet the many requirements of a residential lease. This means that the owner can have the freedom to negotiate with a tenant to come to an agreement that can meet everyone’s needs.
When you are working with tenants on a commercial property lease you can usually expect a little more of a professional relationship. Business owners tend to be more reliable on paying their rent on time because the business is their livelihood. Also business owners tend to take better care of a commercial property because it will represent their business to the public and they want to make a good impression.
Established Hours of Operation
One big advantage of owning a commercial property is that you will receive fewer emergency maintenance requests in off hours. Because commercial properties are not occupied all day and night issues will only be noticed during the hours of operation. This will allow you to relax and not have to worry about responding to too many complex issues at night or on the weekends. Late night emergency calls for things like plumbing can be very expensive.
When it comes to pricing commercial property is often more stable than residential property. In a shifting market commercial property is much less volatile and won’t change quite as fast, though it will change. Commercial properties are also more objectively valued.
The Cons of Commercial Real Estate
If commercial real estate had no drawbacks there would be no way for anyone new to break into the market! But like everything there are definite risks and a significant barrier to entry when it comes to investing in commercial property.
Unlike residential property you really cannot get in on a commercial property without a hefty cash investment up front, unless you are investing in a really small space. The reason for this is that the loans available for commercial properties are much different than a mortgage you would take out for a home. The interest rates tend to be higher and the transaction often requires a bigger down payment because the property itself is more costly.
If you are purchasing a commercial property that isn’t in pristine shape you will also need more cash to address some issues before renting it out. A bigger space means a bigger cost. Think about the difference in repairing a roof on a single family home and a retail space – the cost will be much different.
The cost is the biggest barrier to entry for investing in commercial real estate. If you are a new investor it is unlikely that you will have the cash on hand to invest in a commercial space. That’s why commercial real estate is a space that investors will expand to after some success in the residential market.
Can Be Risky
Of course like any investment commercial property comes with its own risks. Owning a commercial property that will be frequented by the public puts you at higher risk of property damage as well as falls and injuries on your property.
Commercial real estate can also be risky in a volatile market. Though it tends to be pretty stable during normal oscillations in the market, it could be very uncertain when demand plummets. A great example of this was during the COVID 19 pandemic – business owners could not run their businesses so many of them had to close down leaving tons of vacant commercial space with little demand. Long vacancies can be extremely costly. Commercial property is a money maker when there is a tenant but when there is a prolonged vacancy it can become very costly.
Requires Thorough Research
When you decide to get involved in commercial real estate you need to do thorough research before you start spending money. Each little niche within commercial real estate has wildly different needs and is affected by the market differently. You can’t expect an industrial space to react to the market in the same way as a retail space.
Before you get started you need to research what kind of investment is available in your area as well as how that kind of space is faring in the current market. If you don’t do the appropriate research beforehand you could find yourself with an expensive space you can’t seem to rent out or a space so specialized it can only be rented by very specific tenants.
You also need to do your research on the kind of loans available to you for a commercial space. You don’t want to buy a space and use all of your cash on a down payment and not be able to afford necessary repairs.
Can Be Tough Finding A Good Tenant
If you have a great long term tenant owning a commercial property can be a breeze. But if you don’t have that kind of tenant it can be tough keeping your space occupied, especially in an area that doesn’t have a ton of demand.
Unlike residential property commercial space tends to be more specialized to business owners in specific industries. After all, not every business can operate out of a storefront or an industrial space. If you are looking for a tenant to occupy your property you have a smaller pool of potential business than you would residential tenants. Before you decide to buy anything make sure there is some kind of demand there. You don’t want to buy a restaurant and realize later that the demand in the area is for office space.
If you are looking to expand your business or diversify your investment portfolio, commercial property may be a great space to venture into if you have the cash for it. Though there are some obvious and serious drawbacks, many of them can be mitigated if you are in the right position financially to overcome them.
If you are a new investor looking to break into the commercial space the drawbacks need to be taken seriously and weighted accordingly. Always make sure you do the right amount of research before you get involved in any commercial venture because it could just as easily turn into a money pit as a money maker.