Before you jump into a pool or a large body of water, you probably test the water to determine the temperature. The same principle should apply to investing in commercial properties.
You should dip your toe into the proverbial water before going all-in.
What’s the best way to test the commercial real estate water? The answer is to learn the advantages and drawbacks that are associated with commercial real estate investments.
The Pros of Commercial Real Estate Investing
Commercial properties come in many forms:
- Retail malls
- Office buildings
- Apartment complexes
- Industrial structures
- Mixed-use developments
Although there are unique strategies for managing each type of commercial property, the benefits of doing it right can lead to a healthy return on your investment.
Incredible Earning Potential
Commercial real estate typically returns between six and 12 percent return on investment. The amount of return depends on where in the United States a commercial property is located. On the other hand, single-family apartments usually deliver a more modest return on investment of between one and four percent.
Develop Professional Relationships
Business owners take considerable pride in running their operations because they want to maximize profits. You establish professional relationships with tenants of a commercial property, which ensures a longer-lasting relationship. Running a residential property can lead to conflicts with one or more tenants.
Businesses Operate on Your Schedule
Many businesses that rent out commercial spaces operate during normal hours. Even retailers go home at nine or ten in the evening. With commercial real estate tenants, there are no late-night phone calls for maintenance issues or the need to replace a lost key. Even if something terrible happens, you will have an alarm company to contact the proper government department.
Unlike residential tenants, commercial tenants have a vested interest in maintaining visually appealing storefronts and office spaces. This means your interests align perfectly with the interest of your commercial tenants. There is no squabbling because a tenant has neglected taking care of the business.
The Benefit of Triple Net Leases
The primary benefit of a triple net lease is you do not have to cover the costs associated with maintaining individual businesses. It is up to each tenant to make repairs and complete maintenance projects inside the store or office. Every tenant takes care of every expense except paying the mortgage on the property. This includes paying real estate taxes, which can be a financial burden for an investor in a residential property.
Flexible Lease Terms
Because there are fewer consumer protections written into commercial leases, you have the flexibility to negotiate terms such as eviction guidelines and security deposit requirements. This gives commercial real estate investors more financial wriggle room when it comes to creating customized commercial leases that match the needs of each tenant.
Easier to Evaluate Value
Because each tenant can give you an income statement, you have more information to calculate the value of a commercial property. If you decide to work with an experienced broker, you should set the asking price at a price that delivers the cap rate for the type of commercial real estate that interests you.
The Cons of Commercial Real Estate Investing
Although there are several advantages to investing in a commercial property, you need to take into account the few disadvantages that might give you second thoughts.
Substantial Commitment of Time
Commercial real estate requires a much larger commitment to managing the property than the time commitment required to run a residential property. However, you can free up a significant amount of time if you contract with a commercial property management company.
More Vulnerable to Economic Downturns
The COVID-19 pandemic has unfortunately given us a hard lesson about how a swift and severe economic downturn adversely impacts businesses. Because many businesses had to shutter for a few weeks or months, many of the companies had to throw in the towel by closing their doors for good. You should consider whether you have the financial resources to weather a similar future economic downturn.
You’re Going to Need Help
Unless you are a Jack of all trades, you can expect to fork over some of your income to pay for maintenance costs that cover the entire commercial property. As we mentioned hiring a property management company will give you more time to pursue other business interests, but paying a property management company costs between five and 10 percent of your revenue.
Investing in a commercial property typically requires more upfront capital to close the deal than the capital required to close the deal on residential real estate. You also have to consider that your new commercial property might operate flawlessly for several months until one day, the roof caves in because of a storm, or the heating and cooling system decides to shut down. Repair expenses for a commercial property exceed the repair expenses paid by residential property investors.
The Bottom Line
How much risk can you take? That is essentially the most important question of all. Commercial properties buzz with activity all day between customers visiting stores and offices, as well as purveyors dropping off inventory. This means commercial property investors assume a much greater risk of paying for accidents that lead to personal injury claims. From slipping on ice to falling downstairs because of a poorly connected stairway rail, commercial property owners have to budget for more legal costs.
The bottom line is the pros of investing in commercial real estate outweigh the cons if you can handle the additional risks.