Commercial real estate is rarely the first thing that comes to mind when people talk about making investments in real estate and owning property.
That's usually because investing in commercial real estate seems like a huge, complex undertaking, compared to the concept and details of buying a home, which most people understand.
But, it could be a great way for you to have a new revenue stream with higher ROIs (return on investment) if you know what you're getting into.
There are a few important and specific details that set commercial real estate investing apart from residential real estate investing, and it's not so simple as a place where people live versus a place where they don't live.
Residential real estate refers to complexes that consist of between 1 and 4 units to live in. Examples of residential real estate include single-family homes, condominiums, duplexes, triplexes, and quadplexes.
Commercial real estate refers to real estate that falls into any of the following categories: retail, industrial(like warehouses and parking lots), hospitality, multi-family (more than 4 residential units, like an apartment building), and office. Any property that the owner intends to use or lease a property for business and collect rental income will pretty much fall into this category.
1. Higher ROIs
Commercial real estate, when compared with residential real estate, boasts impressive returns in both income and asset appreciation, as long as the vacancy is kept low and the tenants feel their business benefits from renting your property.
From a high-reward perspective, commercial real estate is the winner in real estate. However, there are other factors to consider, when investing, besides the potential for a high ROI and large cash flow.
2. Longer Leases, Less Vacancy
Commercial real estate leases are much longer than residential leases and can typically vary in duration between 3 to 5-year terms, and even longer. This means as long as the property keeps supporting the goals of the tenant’s business, vacancies are not likely to be a problem.
Commercial leases also give more flexibility to the property owner. For example, triple net leases place all property expenses under the responsibility of the tenant. This includes property taxes, maintenance costs, and insurance in addition to the typical cost of utilities and renting the property, itself.
3. Better Relationships (With Tenants)
The relationships between owners and tenants in commercial real estate leases are more professional than those in residential leases. This is because they share common interests in the property’s ability to remain attractive to guests and functional for business.
Both parties have the same goal, which is to generate more cash flow from the property, and this can mean a fruitful business relationship on both sides.
4. Less DIY Maintenance
Many DIY real estate investors start by renting out a few single-family homes. In this case, they can usually handle a lot of the maintenance and tenant relations themselves.
On the other hand, commercial real estate landlords typically hire a property management company to maximize the potential of their property. Property management professionals have the right certifications for the job, and they can be relied upon for repairs, maintenance, monitoring, and improvements.
So as a new commercial real estate owner, day-to-day maintenance would not be something you have to worry about.
1. More Vulnerable to Recession/Economic Shifts
Commercial property tends to be more risk-prone than residential property. Economic downturns hit commercial spaces hard, while residential (due to their nature as a necessity) endures.
A recent example of this would be the COVID-19 pandemic of 2020. During this time, there was a dramatic downturn in demand and rental income for commercial properties like office spaces and retail due to the potential health risk and many governments barring access to many indoor public spaces.
2. Higher Barrier to Entry
Commercial real estate investment has a much higher barrier to entry than residential real estate does when it comes to owning property (different from investing in REITs where you purchase shares as you would with other publicly traded securities). Securing funding, such as a mortgage, is much easier for the investor that's just starting in residential real estate, than one that's interested in commercial property.
Commercial properties are not only much more expensive to start with but there is also a more exclusive market built around them. Lenders recognize the complexity of effectively managing commercial properties and are thus less likely to issue loans for them.
Often, commercial real estate investing is performed by private firms rather than individual investors or entrepreneurs.
3. Needs Professional Attention
Commercial real estate also requires a higher amount of professional ability and experience to successfully procure and manage.
Not just that, due to their scale and nature, commercial real estate depends on capable professionals such as tradespeople, facilities staff, and administrators to operate effectively.
DIY efforts have no place in commercial real estate, so hiring an effective property management company is what most commercial real estate investors do do to keep it fit for business operations. Without high-quality property management, tenant satisfaction and property value can go down significantly.
4. Increased Exposure to Liability
Commercial property owners and tenants could both be potentially liable for any number of issues that may arise because of the higher amounts of foot traffic that occur in these properties. From staff to customers, commercial spaces have much more going on than residential spaces.
The increased exposure to liability, and the sheer scale of how the property is likely to be used, means that commercial property owners, tenants, and managers need to be aware of the importance of security, safety, and insurance to use the property to its fullest potential.
You can be successful as a commercial landlord and generate continuous income on your investment, but only if you're prepared to provide what is needed by tenants and the surrounding community.
You need to do the proper research so you can have the best location (with plenty of foot traffic and active business environment) and property to start with at the right price. Then, you would need to spend more to attract tenants with aesthetically pleasing and modern facilities.
And of course, you need high-quality property management and investment in building technology as well, to make sure your real estate increases its value, operates efficiently, and keeps your tenants happy.