If you are looking to invest in real estate you have two major types of property to choose from: residential or commercial. Commercial real estate is a popular choice for investors and can mean anything from a car wash to an expansive industrial space.
If you are looking to make money in real estate, investing in commercial spaces is a great place to start. Commercial property can be lucrative and may be easier to manage than residential spaces. Commercial spaces can be generic and serve a number of different types of business or they can be niche and only usable by specific industries. Depending on where you are located and how the economy is doing one could be a better investment property than the other.
By definition commercial real estate is property that is intended to be used for business or any endeavor that generates revenue. Commercial property is exclusively used by a business whether that is a storefront or an office or an industrial business. The main difference is that the tenant generally cannot live in a commercial space. Most commercial property is leased out to tenants on a long-term basis.
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Commercial Vs Residential
An investor is not bound to only invest in one kind of property – in fact investing in both commercial and residential is a great way to create a balanced investment portfolio. Still, an investor can choose to pursue one type of investment if it better suits their needs and lifestyle. Some investors may be better suited to commercial properties than others.
Pros
There are a number of reasons why an investor would choose to invest in commercial real estate rather than residential real estate.
One of the biggest draws of commercial property is that leasing rates are generally higher than residential properties. In areas where commercial space is in demand leasing rates can be considerable and generate a significant cash flow. Even in areas that are less competitive you can still see some significant monthly returns.
Another advantage commercial property has over residential property is that tenants tend to turn over much slower. When you are dealing with a residential property, leases can turn over every 12 months or sooner leaving you with vacancies and the burden of finding new tenants. With commercial properties tenants stick around much longer, some can even rent from you for decades giving you a stable, reliable income for a long time.
Finally the availability of capital appreciation on a commercial property is a big draw for investors that are able to maintain the property and keep it properly updated.
Cons
Along with the pros there are also some disadvantages when it comes to choosing to invest in commercial real estate rather than residential real estate.
For one commercial property is inherently more risky. As we saw during the COVID-19 pandemic the tides can turn quickly on certain types of businesses leading to long, expensive vacancies. If your commercial property is in a less desirable area you could see tenant turnover with big vacancy gaps in between. This would not make the investment very worthwhile for anyone.
Another negative for commercial real estate is that there is often a lot more red tape to jump over. From taxes to maintenance regulations, commercial property can be more complicated than your general residential space. Requirements can change from state to state and town to town so having some kind of experience is usually needed. Some places can be very difficult to manuver while others can be a breeze – it really depends on where you are located.
If you have a commercial space, updating and renovating it for future tenants can be costly. Depending on what kind of business you are serving you may need to make specific updates for each new tenant that comes in. With a residential space each tenant tends to require the same things so it is much more straightforward when you are updating the property.
Types of Commercial Properties
If you are looking to invest in commercial properties you have a wide variety of spaces to choose from. Here are the most common types of commercial property…
Retail Spaces
We all know what a retail space is. Retail property can be any kind of storefront or shopping complex. These spaces can be as small as one store space to as large as an entire shopping mall. Retail doesn't just mean clothing stores, it also includes banks, pharmacies, restaurants, supermarkets and more.
Retail real estate ranges from spaces like local strip malls, to community retail centers to malls and power centers. Medium and large retail spaces are often anchored by one or more larger stores with smaller ones in the surrounding area.
Office Space
Office space is the most common type of commercial property and exists in some form in both big cities and small towns. Offices are a diverse type of property ranging from skyscrapers with hundreds of tenants to small buildings with one tenant.
There are three types of office space broken down based on size, condition, location and usage.
Class A offices are big spaces that are new, modern and owned by some kind of large real estate management firm. Class A properties include skyscrapers and office buildings in easily accessible, highly populated areas with lots of amenities. These buildings can bring in a lot of cash and are highly sought after by major corporations. It goes without saying that these kinds of properties are expensive to build and maintain but bring in considerable revenue. These offices are generally occupied by big corporations.
Class B offices are generally older buildings that don’t necessarily require a ton of repairs but require some capital investment. This space is a major target for real estate investors because these buildings don’t require a ton of updates and repairs and are well-maintained, easy to update and rent out.
Class C properties require the most work. A Class C office space would be located in an area that isn’t ideal and deals with higher vacancy rates. These offices require significant investment to make upgrades that will attract tenants.
Multi-Family Buildings
Multi-family buildings may seem like residential spaces but they actually fall into the commercial category. Any residential building with four or more units is considered a commercial space because it is run like one and requires constant management.
Commercial multi-family properties include apartment complexes and high rises. These kinds of properties are the bridge between residential real estate and commercial real estate. Many investors start out with small residential spaces and grow to acquire bigger commercial properties as their capital increases.
Special Purpose Property
So what do you call a commercial space that is made for one specific use? That would be considered a special purpose space. These types of spaces are created to serve a specific industry and cannot be easily adapted to suit anything else. Think of something like a car wash or hotel – it is nearly impossible without major renovations to use those for anything other than their intended purpose.
A big portion of special purpose properties fall in the hospitality and travel category. Things like amusement parks, airports and hotels are commercial spaces built with highly specific purposes.
Mixed-use spaces are also considered special purpose properties. These are structures that are used for more than one thing like a building with storefronts on the first floor and residential units in the floors above.
Industrial
Though they may seem like special purpose spaces, industrial spaces are their own kind of commercial property. Industrial spaces come in a variety of shapes and sizes and serve a multitude of purposes. These spaces can range from the simple warehouse to major manufacturing facilities and distribution spaces.
The most versatile of all industrial spaces is the flex warehouse. This kind of warehouse is kind of a blank canvas and can be easily adapted to suit a variety of different types of businesses. These warehouses often feature large warehouse space with office space on site.
Another type of industrial space is used for heavy manufacturing. These spaces are much more of a special purpose space than a warehouse. These industrial spaces are designed and built to accommodate a lot of specialized equipment. These spaces are highly specialized but can be retrofitted to suit other kinds of businesses.
Industrial space is often a smart investment because tenants occupy the spaces on a long term basis.
Final Thoughts
If you got the chops for it commercial real estate can be a profitable investment for the seasoned investor. Before jumping in it’s important to understand the economy, the area and the type of property you will be investing in. If you choose the right kind of commercial property in the right location you could see steep, long-term returns.
