Is Commercial Real Estate a Good Investment? » Small Business Bonfire

 | 
January 1, 2023
UPDATED: 
January 1, 2023


Commercial real estate is a term used to describe property or land used for business purposes. This can include retail stores, office buildings, warehouses, and factories.

So is commercial real estate a good investment? The answer to this question depends on several factors.

This blog post will discuss some pros and cons of investing in commercial real estate!

First, what is a Commercial Property?

Commercial property is property used for business or investments. This type of real estate is often seen as an alternative to residential real estate, which is used for living in and is usually leased out by the owner.

Commercial properties can include the following:

  • Retail stores
  • Office buildings
  • Warehouses
  • Factories

They can generate more income than residential real estate due to their location.

Commercial Property Acquisition & Financing

When looking to purchase a commercial property, you must be prepared to put forth a substantial amount of money. This is because the cost of acquiring these properties is usually much higher than residential real estate.

Understanding the financing options available when investing in commercial real estate is essential. Generally speaking, obtaining a traditional loan for this type of property is difficult, so alternative financing is usually the most viable option.

These can include the following: 

  • Seller financing
  • Private loans
  • Investment funds
  • Business loans

Commercial Property Upkeep

Commercial real estate is typically more expensive to maintain than residential properties, as they are larger and require more upkeep.

Commercial properties generally have higher occupancy rates and a greater demand for maintenance services such as repairs and renovations.

The business owner typically handles the responsibility for disposing of trash by a business. Depending on local laws and regulations, businesses may be required to provide garbage collection services or contract with a private refuse service provider.

Commercial Real Estate Vs. Residential Real Estate

Commercial and residential real estate are two distinct forms of property ownership that require different considerations from buyers and investors.

Commercial real estate refers to any property used for business purposes, including the following:

  • Office buildings
  • Warehouses
  • Factories
  • Retail stores
is commercial real estate a good investment - real estate

Residential real estate is any property used as a residence, such as:

  • Apartments
  • Townhouses
  • Condominiums
  • Single-family homes

Each type of real estate has advantages and disadvantages that should be considered when considering an investment. 

On the one hand, commercial real estate offers higher investment returns with lower overhead costs than residential properties due to decreased maintenance concerns. This makes it an attractive investment for those looking for a long-term recovery or a steady income stream.

Additionally, commercial properties are more accessible to finance due to their higher liquidity. However, these properties often require extensive renovation to make them desirable to potential tenants or buyers, which can be costly upfront and time-consuming. 

On the other hand, residential property is usually less expensive upfront than commercial properties since they don’t require the same level of renovations or repairs to bring them up to date.

Also, residential properties typically appreciate at a faster rate. Those who invest in them may get higher overall returns on their money in the long run despite lower yields than commercial investments.

Unlike commercial investments, residential rents tend to be more volatile, making it more difficult for investors to predict future trends in value and pricing. 

Overall when considering an investment in either type of property, it’s essential to take into account all the factors involved, including the following: 

  • Location
  • Current market conditions
  • Amenities offered by the building
  • Rental rates/values in surrounding areas

A thorough understanding of what each type offers will allow you to make a more informed decision when choosing between these two types of investments. If you are thinking of opening a real estate business, here are some tips.

Commercial Real Estate Pros and Cons

When investing in commercial real estate, several factors should be considered before making a final decision.

We will look at the pros and cons of commercial real estate to help you make an informed decision.

Pros

The pros of commercial real estate include the following:

  • Income over single family
  • (NNN) triple net lease
  • Tax incentives
  • Limited hours of operation
  • More risk, more reward

Income Over Single-Family

One of the significant advantages of commercial real estate investments over single-family homes is the increased income they can generate.

By investing in the following apartment complex, shopping center, or office building, investors can take advantage of economies of scale and benefit from significantly higher rental income than with a single-family home.

For example, a multi-family property may have eight to ten times more units than a single-family home, generating eight to ten times more rental income.

Additionally, commercial tenants are typically more reliable when paying rent on time and in full because they often have longer leases — ten years or more in some cases — compared to single-family homes, which usually have one-year leases.

Furthermore, commercial real estate investors can usually charge higher rents than those charged for single-family homes due to the added amenities such as onsite gyms, pools, and standard rooms, which many tenants are willing to pay extra for.

Finally, with commercial properties, there is often potential for significant capital appreciation if the property is well maintained and located in a rapidly growing or gentrifying area, thus providing even greater returns over the long term.

(NNN) Triple Net Lease

triple net lease (NNN) is one of the most significant advantages of investing in commercial real estate. In a triple net lease, the tenant pays for all of the operating expenses associated with their space, such as property taxes, insurance, and maintenance costs.

This type of lease arrangement provides landlords with a steady stream of income from their investment property with very few management or maintenance responsibilities. For tenants, a triple net lease eliminates uncertainty around varying expenses associated with occupying a building.

With each cost being predictable and fixed at the start of the tenancy agreement, tenants can plan and budget accordingly without fear of unexpected expenses.

By transferring responsibility for these common area services to the tenant, landlords are ensured that they are not responsible for any unforeseen circumstances – such as major repairs or replacements – that could arise during the term of the lease.

All in all, triple net leases offer landlords more freedom to manage their investment portfolios without worrying about future liabilities while giving tenants more control over their expenses throughout their tenancy agreement.

Tax Incentives

One of the major pros of investing in commercial real estate is the lucrative tax incentives available to investors. Commercial real estate investments are taxed differently than residential properties, allowing investors to unlock a range of money-saving advantages.

Property owners can benefit from deductions that lower their taxable income, potentially leading to significantly reduced percentages of taxes owed on investment profits.

Additionally, certain types of commercial investments may allow property owners to take advantage of accelerated depreciation, which allows them to claim larger deductions more quickly. These deductions can be claimed over the course of multiple years and can provide substantial savings in the long run.

is commercial real estate a good investment - tax incentives

Tax incentives for commercial real estate can also be used to reduce the amount of taxes owed on sale proceeds.

Capital gains taxes are assessed when an investor sells a property at a profit and can be reduced through measures such as 1031 exchanges or cost segregation studies.

By taking advantage of these opportunities, investors can reinvest their profits into other properties without paying additional taxes upfront, allowing them to grow their portfolio quickly and efficiently. 

Limited Hours of Operation

One of the great advantages of investing in commercial real estate is that it often has limited hours of operation. This can be a distinct benefit for landlords looking to maximize return on investment and keep their tenants happy.

Tenants don’t have to worry about being overworked or constantly subject to unsociable hours, as a result of which they will be more likely to remain in their property for longer.

Moreover, the likelihood of disruption from outside sources, such as noise and other disturbances, is minimized when activities within the building are confined to normal working hours.

More Risk, More Reward

Investing in commercial real estate is a high-risk venture, but with higher risk comes higher reward.

Investing in commercial properties allows investors to access potential returns that are considerably higher than returns associated with residential investments – even if the market is relatively stagnant.

Commercial real estate is also less impacted by short-term fluctuations in the market and is typically more resilient to crises. Even in economic downturns, commercial properties tend to experience slower declines in value than residential properties.

Ultimately, while investing in commercial real estate is a risky proposition, it can also be an incredibly lucrative venture if done correctly. Investors willing to take on more risk may find that the potential rewards associated with commercial real estate are well worth it.

Cons

Some of the cons to investing in commercial real estate include the following:

  • Upfront investment
  • Time commitment
  • Professional help needed
  • More risk, more risk

Upfront Investment

Commercial real estate is an investment that requires a substantial amount of upfront capital. \

Investors need to have sufficient funds available to purchase the property and cover associated costs such as:

  • Legal fees
  • Taxes
  • Insurance

Without the proper resources, investors may be unable to capitalize on potential opportunities or fully explore their options.

Time Commitment

Investing in commercial real estate is a long-term commitment that requires considerable amounts of time and dedication.

Property owners need to:

  • Resolve any disputes
  • Monitor tenant activity
  • Stay on top of their investments
  • Handle financial matters such as rent collection

Professional Help Needed

Commercial real estate is a complicated investment that requires professional help from a variety of personnel, such as lawyers, accountants, and bankers.

These professionals can provide valuable advice on the best ways to structure deals and manage properties, which is essential in order to maximize returns on investment.

More Risk, More Risk

Investing in commercial real estate is inherently riskier than investing in residential properties.

This is largely due to the fact that commercial properties have higher vacancy rates and longer lease periods, as well as lower liquidity, making it harder to liquidate assets if needed quickly.

It is also important to consider possible economic downturns and changing market conditions, which can have a significant impact on the value of commercial properties.

Now You Decide

While there is no guarantee of success, investors willing to take on more risk may find that the potential rewards associated with commercial real estate are well worth it.

By weighing the risks and rewards, investors can make an informed decision about whether or not commercial real estate is a good investment for them.

Do you have any questions about commercial real estate? Let us know in the comments!



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Author

  • Chuck Parsons

    Chuck is Score LA’s Executive Director of Events and Marketing. He aims to help business owners and would-be entrepreneurs in Los Angeles improve their business practices.

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