Commercial real estate can be a great investment for business owners and individuals alike. However, like any other type of investment, there are pros and cons to consider before making a decision. In this blog post, we will take a look at some of the Pros And Cons Of Investing In Commercial Real Estate.
Rising interest rates have not deterred investors, as the commercial real estate market remains strong in 2022. While forecasts vary among asset classes, they show a positive industry outlook heading into the second half of the year
Key Takeaways
- Investing in commercial real estate can be a great way to diversify your portfolio and increase your income.
- Commercial real estate offers a stable investment that won’t fluctuate as much as other investments, like stocks.
- Commercial real estate takes time and effort to manage properly, so it’s not for everyone. You’ll need to find good tenants who pay their rent on time and take care of the property.
Table of Contents
What Is a Commercial Property?
Commercial property is a building or other real estate that is used for business purposes. Commercial properties include offices, factories, warehouses, retail spaces, hotels, and more.
Commercial properties can be owned by individual companies or they can be owned by institutional investors such as banks or insurance companies. The property owner usually leases them to tenants who pay rent to use the space.
Types of Commercial Real Estate Properties
When you think of commercial real estate, what comes to mind? Maybe you’re picturing a small business like a coffee shop or a gas station. Maybe you’re thinking about a big chain store like Target or Walmart. Or maybe you’re picturing a warehouse for storing something like cars or food.
The truth is that commercial real estate comes in all shapes and sizes. Many different types of commercial property investment can be used for all sorts of different purposes, from housing small businesses to storing huge amounts of inventory.
Read more about types of commercial real estate properties here.
Pros of Investing In Commercial Real Estate
Income Potential
One of the best things about investing in commercial real estate is its income potential.
Commercial real estate is a diverse category that includes everything from office buildings and retail establishments to warehouses, storage facilities, and more. Each of these types of properties has a different purpose and offers different advantages to its investors.
In addition to the standard stock market, commercial property also offers an excellent opportunity for investors looking for a steady stream of income
Inflation Protection
Inflation protection is one of the biggest advantages of investing in commercial real estate.
As inflation rises, the value of your investment will increase as well. This means that if you choose to sell your property at a future point in time, you’ll be able to get a higher price than if you had invested in another asset class.
Funding Availability
The availability of funding for commercial real estate has been improving over the past few years, with low interest rates and a growing number of investors looking to take advantage of the current market.
The availability of funding for commercial real estate has been improving over the past few years, with low interest rates and a growing number of investors looking to take advantage of the current market.
Tax Advantages
Owning a commercial property requires substantial renovation, maintenance, and upgrading. These expenses are tax-deductible.
These expenses are out of pocket, but because they improve the value or attractiveness of your building (and might be paid on a leased property anyway), it’s worth considering how to include them.
If you work full-time and purchase a home or apartment primarily to use as your primary residence, the costs of these property taxes could be deducted.
Diversification
Diversification is one of the biggest benefits of investing in commercial real estate.
If you only invest your money in one type of asset, such as stocks or bonds, then you’re vulnerable to any number of outside factors that could affect its value. If a company you own stock in goes bankrupt and goes out of business, for example, then you could lose all your money.
But if you invest in commercial real estate and other types of assets as well, then even if one investment loses value (like stocks), another might gain value (like commercial real estate). This means that overall your portfolio is less likely to suffer a loss and more likely to see gains over time.
Dispersion of Vacancy Risk
Dispersion of vacancy risk is one of the biggest advantages of investing in commercial real estate. If a few tenants leave your building, you don’t have to worry about it causing a domino effect. It’s not like retail, where if one store closes, it can be really hard to find someone to replace them.
If a few tenants leave your building and their space is vacant for a while, it’s no big deal. It’s not like retail, where if one store closes and its space is vacant for a while, it can be really hard to find someone to replace them.
”Forced” Appreciation
Commercial real estate tends to appreciate over time because it is an essential part of every business and community. As more people move into an area, the demand for commercial properties increases, which drives up its value over time.
Flexible terms
When you invest in commercial real estate, you can choose the terms that work best for you. You can choose to put down a large down payment and pay the rest over time, or you can choose to keep things simple and just make an all-at-once purchase. Either way, you’ll be able to get started with minimal hassle!
Lease Escalations
One of the best ways to get a return on your investment is through lease escalations. This can be in the form of a rent increase or an increase in the square footage lease. Either way, it’s a great way to make money when you invest in commercial real estate.
Passive Income
One of the biggest benefits of investing in commercial real estate is the passive income that comes with it. Commercial properties tend to have higher rental rates than residential ones, which means that you can collect rent payments without having to be there all the time. This is especially helpful if you’re working on other projects and don’t have time to manage your investments.
Professional tenants
One of the biggest pros of investing in commercial real estate is that tenants are typically more professional and predictable than residential tenants. They are used to paying higher rent prices, so you can expect them to be reliable and timely.
Emergency interruption potential
When you invest in commercial real estate, you’re not just investing in the property itself, but also in the tenants who occupy the space. If something happens to the tenant and they move out of the building, that means you’re left with a space and no income until you find another tenant to take their place—which can be a lengthy process if there isn’t a large pool of potential tenants to choose from.
On top of that, your property taxes may go up if you don’t have a tenant paying rent. This means that emergency interruption potential is one of the biggest pros of investing in commercial real estate—it reduces your risk and offers some insurance against losing money.
Logical, steady pricing
When you invest in commercial real estate, you’re not just buying a piece of property—you’re buying an investment that will appreciate over time. Commercial real estate prices are more stable than residential, which means that your investment is less likely to fluctuate wildly based on the economic climate.
Triple Net Leases
One advantage of these leases is that they tend to be quite flexible: they cap the annual increases in taxes and insurance.
For the landlord, triple net leases can act as a steady source of income and eliminate much of the overhead otherwise required for managing property.
Stable Investments
The longer you hold onto a commercial investment, the more it’s likely to appreciate. Commercial properties are much more recession-proof than residential properties and tend to be less affected by economic downturns.
Flexible buying options
Buying commercial real estate can be a stressful process. You want to buy the right building, at the right price, with the right terms—and that can take a lot of time and money. It’s not easy to find a building that checks off all your boxes, so you’ll need to be flexible when it comes to your purchasing options.
Long-Term Leases
Long-term leases are a huge benefit of investing in commercial real estate. When you invest in residential real estate, you have to be prepared to deal with tenants who might move out or cause problems at any time. This can be stressful and difficult for the landlord, who has to deal with constant turnover and the challenges of finding new tenants.
But when you invest in commercial real estate, things are much different. Commercial tenants generally sign multi-year leases, which means that they’re going to be paying rent for several years at a time, rather than month-to-month. This stability makes it much easier for both landlords and tenants to plan—and it helps ensure that everyone gets what they need out of the relationship!
Cons of Commercial Real Estate Investments
Cost
The biggest con of commercial real estate investments is the cost.
If you’re looking to invest in a commercial property, you’ll have to pay for it upfront. That means you’ll have to have cash on hand to cover the entire cost of the purchase and renovations.
Management Intensive
One of the cons of commercial real estate investments is that they are highly management intensive. In addition to the initial investment, you will need to hire a professional property manager who will take care of all aspects of maintaining and running your property. This can be a very time-consuming process and often requires a significant amount of upfront money.
Increased Vacancy
While it’s true that commercial real estate investments can be a great way to make money, it’s important to remember that there are risks involved. For example, if your property is vacant for too long, it can hurt its value and even become worthless.
Credit Risk
Credit risk is one of the most important factors to consider when purchasing commercial real estate. When purchasing real estate, you will need to obtain loans in which your credit will be reviewed. The ability to make payments on your real estate loans will impact your credit score.
When you take out a multimillion-dollar loan for this type of real estate, you are putting your credit score in danger. If you do not make timely payments, your credit rating may suffer and you will be charged a higher interest rate. As a result, to best manage credit risk, you must ensure that you can take on loans that you and your organization can afford.
Public Safety
The buildings in which you invest are likely to be in high-traffic areas, so they need to be secure. If a building does not have adequate security measures in place, it could lead to theft, vandalism, and other issues that can take away from your bottom line.
Market Risk
The market risk associated with commercial real estate investments is the risk that you will lose money on your investment due to changes in the market. This can happen for several reasons, including but not limited to:
The overall economic climate. If the national economy is going through a recession or depression, it may be difficult for businesses to make money and therefore they may have trouble paying their rent on time. This could lead to an increase in vacancies and therefore an increase in vacancy rates.
Changes in interest rates. If interest rates rise, this will decrease demand for commercial real estate because it becomes less affordable for investors. It also makes it more expensive for businesses who want to buy or lease space, which will cause them to look elsewhere for alternatives (which may include renting less expensive offices).
Time requirements
While it’s true that commercial real estate can be an excellent investment, it’s not the right choice for everyone. It takes time to find the right property, negotiate with sellers and buyers, and manage the property after it’s been purchased. If you’re looking for a fast turnaround on your investment, this may not be the right choice for you.
Monetary requirements
One of the biggest cons of commercial real estate investments is the monetary requirements. Most investors have to have a certain amount of money available to start investing in commercial real estate.
Risks
There are many risks involved in investing in commercial real estate.
The first is that the building you buy may not be as valuable as you thought it would be. If a building is falling apart or located in an area that is less desirable than you anticipated, then it may not appreciate as quickly as you’d like it to.
Another risk is that there will be issues with the title to your property. This can happen if there are liens on the property that weren’t disclosed before purchase, or if there are problems with zoning laws or property use restrictions that could make it difficult for you to sell or rent out your investment.
The need for professional advice
Commercial real estate investing is a competitive field, and it requires both experience and expertise to be successful. If you are just starting in this field, you should consider hiring a professional to help you get started. A good commercial real estate investor will be able to guide you through the process of purchasing the right property at the right price and helping you decide which properties are worthwhile investments.
Current Trends in Commercial Real Estate Investments
The housing market’s hot streak will most certainly continue.
According to CBRE, in 2021 multifamily investments reached $179 billion by Q3. Several conditions such as low availability of housing and the preference for quality dwellings over less expensive options contributed to this pattern. In the coming year, investors should monitor potential oversupply to make decisions accordingly; however, it seems that strong performance can be expected nonetheless.
The Federal Housing Finance Agency limited the number of multifamily purchases to $78 billion, or 11.4% higher than in 2021. This lays a solid foundation for future demand in markets such as secondary and suburban areas, alongside growth in hybrid work and family formation.
Los Angeles Commercial Real Estate Investment Opportunities
Los Angeles is a city filled with opportunities, and it’s not just because of the endless amount of things to do. The city also has an extremely large commercial real estate market, which makes investing in it an excellent opportunity for those who are looking to make some money.
The state of California is one of the largest states in the United States and is home to some of the biggest cities in America. It’s no surprise then that Los Angeles has become one of the most popular places for people living in California or even outside of California to live.
There are many reasons why investors would want to invest in commercial real estate in Los Angeles. First of all, there are plenty of different types of businesses that have offices here so there are many opportunities for investment properties such as office buildings or shopping malls. Secondly, because there are so many people living here who need places to live or work it means that there are always going to be new properties being built which means more chance for profit!
Commercial vs. Residential Real Estate Investments
The technical distinction between residential and commercial real estate is as follows: Residential real estate consists of single-family homes, duplexes, triplexes, or fourplexes.
Commercial property is anything with five or more units. Residential property real estate includes condos, duplexes, and quadruplexes whereas commercial real estate includes office space, retail stores, industrial buildings—anything from hotels to special-use facilities (like airports).
A significant difference between commercial leases and residential properties is the type of tenant that each attracts. Commercial buildings are often leased to corporations, whilst families tend to fill residences.
FAQs
What are the disadvantages of commercial real estate investment?
Cons of commercial real estate include high upfront costs, longer vacancies, and property management challenges. Risks involve economic downturns, tenant defaults, and property-specific issues. The biggest problems are oversupply, shifting demand, and regulatory changes. Thorough due diligence is crucial to determine if a property is a good investment.
What is the risk of investing in commercial real estate?
Risks of investing in commercial real estate include market volatility, tenant instability, property maintenance costs, and financing challenges. Economic factors and industry trends can significantly impact the success of office buildings and other commercial properties. Careful research and risk assessment are essential before investing.
What is the biggest problem in commercial real estate?
The biggest problems in commercial real estate are oversupply, shifting demand, and regulatory changes. Overbuilding can lead to high vacancy rates while evolving tenant preferences and economic conditions can affect property values. Adapting to market dynamics and staying informed about local regulations are critical for investors.
How to know if a commercial property is a good investment?
Evaluate the pros and cons of commercial real estate, such as income potential, diversification benefits, and management responsibilities. Assess the risks and rewards of investing in small-town commercial real estate or office buildings. Conduct thorough due diligence on the property, market, and financials to make an informed decision.
What is a good ROI on a commercial property?
When assessing the viability of a commercial real estate investment, calculating the return on investment (ROI) is essential. Generally, a strong ROI in the real estate sector falls between 8% and 10%. However, it’s important to consider additional factors, such as market trends and potential risks, to make a well-informed decision.
Conclusion
So, what do you think? Are the pros of investing in commercial real estate worth the cons? If you’re still on the fence or would like more information before making a decision, please give us a call. I would be happy to discuss your investment options with you and answer any questions you have about this exciting market. Alternatively, if you’d like to get started right away, head over to our website and schedule a consultation with me.
