Pros and Cons of Investing in Commercial Real Estate
Property, either commercial or residential, is a secure investment opportunity. Commercial properties are a better investment for financial gain than residential properties as they offer a monetary reward. However, it also comes with several risks.
To comprehend, the pros and cons of investing in a commercial property are imperative so that you decide which investment is better for you.
There are many differences between commercial and residential property investing. Buying a commercial property can help you improve and diversify your portfolio as an investor.
Hence, for beginner-level investors buying a commercial property can be a challenging yet complicated process. On the contrary, well-advised commercial property can provide a great reward. So, to minimize your risk and maximize your reward, we have enlisted the pros and cons of investing in commercial property:
Types of commercial real estate properties that you can invest in:
“Mixed-use” is the property that may comprise a combination of uses, for instance, retail, office, apartments, etc.
Benefits of Investing in Commercial Real Estate
1. Higher rental yields
Commercial property at a prime location can offer higher rental income than any other residential property. With an enhanced annual rate of return, the value of retail and offices also improves over time if they are adequately maintained. Updated and modern infrastructure projects and the development of residential projects in the area can also increase the overall value of commercial real estate.
While a higher return on investment is a massive motivation for investors looking to enter the commercial real estate market, one of the most significant advantages of investing in a commercial property is constant income.
Retail tenants are usually interested in maintaining their store and storefront. The reason behind this is because if they don’t, it might affect their business. Consequently, commercial tenants and property owner interests are in sync, which assists the owner in maintaining and improving the quality of the property, which enhances the value of the investment.
Investors can meet their desired income stream via an indirect investment strategy and a triple-net leased property. This is similar to a bond but with a higher return.
2. Longer Leases
Another advantage of investing in a commercial property is that commercial property can attract long-term leases, which may be extended to 3-5 years or more. If you secure stable and reliable long-term tenants such as large corporations, organizations, government departments, etc., you can sit back and relax for years to come.
3. Lower Outgoings
Being a landlord of a well-located commercial property brings you the benefit of lower outgoings. Tenants are responsible for all outgoings, such as expensive council rates and any owner corporation’s fees.
Moreover, if a tenant decides to make substantial changes within a premise, they are responsible for the fit-out and costs. In contrast to the residential properties, the tenant is responsible for covering their share of the outgoings such as strata, utilities. Commercial tenants use their rented premises to execute their business which gives them an incentive to maintain and take care of the property.
4. Portfolio Diversification
If you own an apartment for additional rental income, investing in a commercial property can further strengthen your portfolio. However, you must make sure that the property is well-located and has a strong infrastructure. Buildings with a secure parking space and accessible from the main road may have a higher cost than those situated further. However, they can also generate higher costs and make up the difference over time.
If you have invested in a residential property, buying a commercial property; located in a prime location and with good quality can diversify your portfolio to a great extent. To make sure that you are getting the best you can afford, it is advised that you seek help from experts such as solicitors, brokers, and buyer agents.
5. Stable Investments
Due to loose correlation to bond and stock prices, commercial real estate investments can provide a stable influence on your portfolio performance. Their prices are less unstable because they are not traded publicly, and different asset classes such as multifamily are inclined to be challenging in all phases of an economic cycle.
6. Enhances Professional Relationships
Buying a commercial property allows you to build long-lasting relationships with other businesses and corporations. Furthermore, many commercial buildings are operated under the Limited Liability Company (LLC) structure. This protects your investment and minimizes liability in the long run. Since business-to-business relationships are highly professional, establishing an LLC can assist in keeping things more manageable and straightforward between parties, owners, and tenants.
Cons of Investment
The commercial property requires hefty up-front capital as compared to residential property. A large, unique space may also come with unexpected expenses that may cost a lot. Shops and office buildings with everyday costs located in prime locations are bound to be more costly than the older, remote ones.
Most desirable commercial properties are highly expensive and are affordable to only well-funded investors and firms. This projects two major risks. First, since commercial properties are so costly, they require a sizable amount of capital, which indicates a loss of a hefty amount of capital. Secondly, the number of resources needed to purchase one may restrict investors’ ability to diversify their portfolios.
As mentioned above, commercial properties can generate a higher ROI and thus can bear high-value appreciation.
2. Economic Shocks
The demand for commercial property is more elastic than the demand for residential property. Hence, the biggest con or drawback of investing in commercial property is its sensitivity towards economic conditions. Many businesses and retail services are connected to the strength of the economy. In case of a mild recession or economic downturn, the demand for commercial properties declines. In contrast, the demand for residential properties manages to stay firm since everyone needs a place to live.
On the contrary, when the economy is stabled, and projects sound growth, the commercial real estate market reaches the ceiling. Thus, commercial property is subject to an economic shock.
3. Repairs and Maintenance
Tenants bear the cost of maintenance and repair if an upgrade is needed to maintain the quality of the property. However, this can cause a costly disruption in the tenants’ business. Commercial properties require more maintenance in contrast with residential ones.
The sole purpose behind this is that many people visit commercial premises, increasing the need for repairs and maintenance. It is also essential to ensure that your property has a sound infrastructure to reduce the risks of accidents.
Owners of the building must be mindful of which parts of the building need urgent repair and maintenance or equipment in the building that need to be replaced to avoid property damage or any liabilities.
4. Market Risk
A disadvantage of investing in commercial real estate is the market risk. It refers to the risk that market conditions could impact the property’s value. This changes certain factors such as rental rates, property taxes, absorption of space, interest rates, etc. It is important to understand that these changes can happen unexpectedly, which is why investors must anticipate and protect against their impacts.
To sum up, there are many advantages to investing in commercial real estate. However, it is a daunting task for a beginner.
Many investment firms allow investors to income-producing commercial real estate options without expertise or the resources required to execute or manage such properties. If this interests you and you want to explore this type of investment, you must seek guidance from a professional to guide you about this process.