April 23, 2024

Investing in Commercial Real Estate: All You Need to Know 

7 min read
commercial real esatate

It’s not a secret that the safest form of investment is real estate investment. Investing in real estate is the best way to diversify your investment portfolio and potentially build capital.

There are different real estate investment options and strategies. And one of those options includes commercial real estate.

In this article, we will explain what commercial real estate is and all the pros and cons of investing in it. Let’s begin.

What is commercial real estate?

Simply put, commercial real estate is any property used for professional or business purposes. Commercial property can also be described as any property that can generate profit through rental income or capital gain.

Properties such as office buildings, retail buildings, warehouses, and apartment buildings are all considered commercial properties.

Difference between commercial and residential real estate

People generally have more knowledge and information about residential properties. And that’s why they think that all real estate is the same. But that’s not the case.

When it comes to commercial properties, it’s important to know that there are some major differences. 

For example, in most cases, you can’t live in a commercial property you invested in. Another major difference is the risk factor. Compared to residential real estate, investing in commercial properties comes with greater risks even though the return potential is higher.

Similarly, investing in commercial real estate is usually more complicated than investing in residential properties. And that’s probably one of the reasons why people know so very little about it.

Pros of investing in commercial real estate

Now that we have an idea of what commercial properties are, we can talk more about the pros of investing in them.

1. Income potential

The upfront cost of investing in commercial properties may be higher but the income potential is greater. This is one of the biggest reasons people decide to invest in commercial properties.

There are a couple of reasons why the total income potential is greater than when you invest in residential properties. To begin with, commercial properties are generally more valuable than residential ones. This is because people use them for professional and business purposes.

Then, it’s not a secret that commercial real estate is larger and thus it can accommodate more tenants at the same time, which automatically means more income potential. 

2. Building professional relationships

Since we’re talking about tenants, the other benefit of investing in commercial real estate is professional tenants and LLCs. Having professional tenants means building professional relationships, instead of landlord-tenant relationships.

On top of that, they will operate the property as a business so you won’t have to worry about the condition of your property. It’s in their best interest to keep their business (your property) in top condition.

3. Fewer hours of operation

According to experienced real estate agents from Define Property, investing in commercial properties is much more peaceful than investing in their residential counterparts. You don’t have to worry about getting tenant emergency calls in the middle of the night.

Since businesses will be renting these properties, and businesses rarely operate at night, you won’t be bothered at night.

Also, commercial buildings are more likely to have built-in monitoring systems, so even if something does happen at night, the system will notify the authorities.

4. Forced appreciation

You, as the investor, can control the value of your investment property based on the increase of NOI ( net operating income) – that is called forced appreciation. You can increase NOI in different ways, either through add-value projects such as renovations or expanse management.

So, for example, buying low-quality bad investment properties and turning them into good investment properties, that’s how you force the value of the property to rise.

5. Triple net leases

Some commercial properties have this lease agreement structure, known as triple net leases, where the tenant agrees to pay the base amount plus all the costs associated with maintenance, utilities, and taxes.

This means that you, as a property owner, have no management responsibilities apart from paying the mortgage. A great benefit, you don’t really have in residential real estate.

6. Inflation protection

One of the greatest benefits of investing in real estate is an inflation hedge. This also includes commercial real estate. No matter the size of inflation, the demand for properties will always be there.

And the best of all is that the prices of real estate won’t be affected by the economic climate. When inflation starts to rise, so will the rents and thus, property values. And that’s how investing in commercial real estate can hedge inflation.

7. Passive income

There are different ways in which you can generate passive income through commercial real estate. A triple net lease is one option, the others include investing in REITs, syndication, investing in commercial real estate companies, or mutual funds.

Either one of these investment options can generate passive income. Whichever you choose, you won’t be wrong.

8. Flexible leases and buying options

Unlike residential leases, commercial ones are much more flexible and aligned with your personal goals. You can create various lease agreements and negotiate with potential tenants. And since potential tenants are businesses and LLCs, negotiating and coming up with a favorable lease option won’t be a problem.

In commercial real estate, you also have flexible buying options. This means that you have more investment options, you can invest in business buildings, warehouses, factories, or storefronts. All this makes it easy for you to diversify your investment portfolio and improve earnings. 

Cons of investing in commercial real estate

Where there are pros, there are cons as well. When talking about investment, it’s important to consider both the good and bad sides of commercial real estate investing.

1. Risks

As mentioned, the risks of investing in commercial real estate are higher than investing in any other form of real estate. There are always credit and market risks to consider.

The risk of the tenant not being able to pay their rent is called credit risk and market risk is when the situation on the market can affect the value of your property.

Both of these risks are pretty much out of your hands, but you should be aware of them before investing in commercial real estate

2. Costs

Investing in commercial properties requires more money initially because the costs of commercial properties are quite high.

So, to invest in a property of this kind, you’ll need a significant amount of capital. This is a risk in itself because there’s still the chance of losing that significant capital.

Then, because of the high prices of commercial properties, you are limited to only purchasing one property which in turn, limits your ability to diversify your portfolio.

3. Increased vacancy

Commercial properties are always at risk of increased vacancy. This is because the number of tenants is always smaller than in residential properties. The loss of a tenant can significantly affect the income potential of a property.

4. Help with management required

Because of the scale of commercial properties, you’ll need help managing them. You alone won’t be able to handle and manage your commercial property.

This only means more expenses because you’ll need to hire a property management agency.

Trends in commercial real estate in 2023

Even with all the pros and cons of commercial real estate, you need to know current market trends to be able to make the right decision. So, here are some of the trends in commercial real estate this year.

Smaller properties and shorter leases

More and more businesses are transitioning from onsite to remote or hybrid work structures. This means that the need for huge, multiple-floor offices is no longer necessary.

It’s important for you, as a commercial property owner, to know that tenants are looking for smaller properties. For properties that offer just enough space to fit their necessities.

Similarly, today, tenants and LLCs prefer rents that offer short-term leasing options.

Implementation of technology

One very popular trend in real estate today is cost-cutting technology. More and more investors are looking for properties that feature technology that can automate processes and tech that controls energy consumption and tracks overall spending.

Recently, technology has gained quite a bit of popularity in the real estate industry. So, keep that in mind, when looking for investment properties.

Sustainability

Just like technology, another requirement is sustainability. Commercial real estate investors are doing their best to convince developers to consider the environmental aspect of building a property.

Environmental, social, and governance (ESG) investing principles are finally being taken seriously.

Cybersecurity

Yet another trend in the commercial real estate investment landscape is cybersecurity. As an investor you need to protect yourself, your tenants, and their information. And since more and more transactions are being made online, cybersecurity in commercial real estate is a priority.

Conclusion

Sometimes the pros outweigh the cons. In general, investing comes with numerous risks. However, investing in real estate is the safest form of investing.

Whether you decide to invest in commercial or residential real estate that’s up to you. It’s just a good idea to know both the advantages and downsides of investing in commercial real estate.

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