Commercial real estate offers investors an opportunity to earn a steady income, accumulate wealth, and even operate a business if they want to. It can be an exciting and lucrative investment. However, it also comes with risks that you should be aware of before you dive in
Commercial real estate includes a surprising variety of different properties, each with a unique set of benefits and challenges. In this guide, we will explore the key pros and cons of owning commercial real estate.
What Is Commercial Real Estate?
Commercial real estate is any property that is used for business purposes, including residential properties that are rented out.
Commercial real estate includes:
- Retail spaces such as shopping centres, strip malls, and stand-alone stores.
- Office buildings, including corporate offices, medical buildings, and coworking spaces.
- Apartment buildings, multi-unit residential properties, and mixed-use properties
- Self-storage facilities.
- Industrial buildings such as warehouses, distribution centers, and manufacturing facilities.
- Healthcare facilities such as hospitals, clinics, and long-term care facilities.
- Student housing.
- Car dealerships and auto repair shops.
- Hospitality properties such as hotels, motels, resorts, event venues, restaurants, and coffee shops,
- Agricultural properties and farms, including wind and solar farms.
Benefits of Owning Commercial Real Estate
Owning commercial real estate has benefits that residential real estate does not offer:
Steady Income Potential
Commercial properties are usually leased out to other companies or residential tenants rather than being used by the owner. With the exception of residential tenants, commercial leases tend to be longer, often from 5 to 10 years or longer. This provides steady, reliable rental income for the owner that they can use for other investments or to service debt.
Commercial property owners can further ensure a steady income with Triple Net Leases (NNN leases) that require the tenant to pay property taxes, insurance, and maintenance costs. Although these leases require very reliable tenants, if the commercial property owner can find them, these tenants are worth holding onto.
Asset Appreciation and Equity Growth
Like residential properties, commercial properties tend to increase in value over time. Owners build equity steadily, allowing them to borrow against the property for improvements or other investments.
Higher ROI
One of the biggest benefits of owning commercial real estate is that it typically offers a higher return on investment (ROI) than owning residential properties. Capitalization rates (net operating income ÷ property value) can range from 5% to 12%, depending on location and property type.
Portfolio Diversification
Owning commercial real estate is an investment for most people, and adding it to a portfolio helps diversify their holdings. The result is a portfolio that is less subject to fluctuations in the stock market and other types of volatility.
For even greater diversification, commercial real estate owners can buy different types of property, further reducing their risk. For example, office spaces are not currently in high demand, but industrial spaces and warehouses are. An investor with both types of properties is better equipped to weather slowdowns and losses in a specific sector.
Tax Benefits
Owning commercial real estate has significant tax advantages. Investors can deduct mortgage interest, depreciation costs, property repairs, maintenance costs, some property management expenses, and other operating expenses. In some cases, even operating losses can be used as tax deductions. Consulting with a tax advisor to maximize your deductions and identify tax-deferred strategies is a smart business idea.
Disadvantages of Owning Commercial Real Estate
Despite the many benefits of owning commercial real estate, it does have downsides.
High Initial Costs and Financing Issues
Commercial real estate generally requires much larger down payments than residential real estate, often 20 to 30% of the purchase price, and interest on mortgage loans is typically higher.
It can also be much more difficult to get financing for these types of properties. Lenders require higher credit scores and other evidence of creditworthiness, as well as higher net worth.
Occupancy Risk
Unless your purpose in owning commercial real estate is to use the property yourself, your income is dependent on having a high occupancy rate. Even apartment buildings, multi-unit dwellings, and mixed-used buildings will have lower occupancy rates from time to time, and commercial real estate owners must plan for this carefully.
The situation can be even riskier with industrial buildings, retail spaces, and hospitality properties, where economic downturns can leave these properties sitting empty. Post-pandemic, many office buildings have lost tenants, and owners have had to come up with creative ways to repurpose these spaces, at great expense.
Property Management
Owning commercial real estate means handling tenant issues, maintenance, and compliance challenges. Landlords sometimes choose to take on these responsibilities themselves, but many hire a property manager, which can cost up to 10% of their rental income.
Liquidity Challenges
Commercial real estate is not particularly liquid. Unlike residential real estate, selling a commercial property can take months or longer.
Is Owning Commercial Real Estate Right for You?
Owning commercial real estate is ideal for investors who are looking for long-term investment growth and passive income. However, they must have capital on hand for the larger down payment that is required and the operating costs they will need to pay regardless of income flow. Investors must have a high-risk tolerance to be able to weather market fluctuations and periods of low occupancy.
If this sounds like you, owning commercial real estate is a great option that allows you to diversify your investment portfolio and enjoy steady income for years to come. Thinking about investing in this exciting sector? REMAX has experts who specialize in commercial real estate and can help you find properties that are ideal for you. Contact one today to explore the best opportunities available!
