As a real estate broker, I have worked with a lot of investors over the years that wanted to make the transition from investing in residential properties to investing in commercial properties. For many investors, commercial real estate is appealing because of the large amount of money that flows through a commercial property. While commercial real estate can be an excellent investment, there are a number of things to consider before taking that leap. While multifamily properties of over four units is considered commercial real estate, for the sake of this post we’re going to discuss properties that businesses operate from; office, retail, industrial/warehouse, hospitality, etc.
One thing is certain, people will always need somewhere to live. No matter how good, or bad, the economy is, most people’s top priority is to have a roof over their heads. This is what has always made residential investments a fairly safe investment. The same isn’t always true with commercial properties. Changing market trends can leave certain properties obsolete. Just 10 years ago, the demand for retail investments was high as investors wanted to stability of the national chains that occupied them. Today, however, many investors are left with vacant retail buildings and no idea of how to find another user.
Acquiring New Tenants
One of the most appealing things about investing in commercial real estate is the long-term leases and the limited maintenance responsibilities for the property owner. Most retail and industrial/ warehouse spaces have leases that require the tenant to pay their share of property taxes, property insurance, and maintenance. That means if there is a plumbing issue, or the furnace goes out, it’s the tenant’s responsibility to fix it.
Of course, there is another side to that coin. In most markets, a vacant apartment or house can be filled fairly quickly. Commercial spaces typically take much longer to fill. I always tell clients that are interested in investing in commercial real estate to be sure that they can afford to keep the property during long periods of vacancy. Commercial spaces can take months, or even years for specific use spaces, to fill.
In addition to waiting a while for a new tenant, there can often be some significant costs involved with acquiring a new tenant. Since a new tenant likely won’t have the same space requirements as the previous tenant, it’s likely that the tenant will require modifications to the space. This can involve some significant construction costs. It’s also likely that a commercial real estate agent will be involved with the lease transaction. The commission on a commercial lease is a percentage of the total lease value, which usually has to be paid up front. That means on a five-year lease, the commission will be based on the total amount to be collected for the full term, and paid once the lease is signed. It’s common for the property owner to have to wait for two or more years to recover the cost of acquiring a tenant.
Selling The Property
In most cases, a residential investment property is fairly easy to sell. If the need to cash in on some equity comes up, the property can usually be sold in a relatively short time to fulfill those cash needs. While some well performing commercial properties with great credit tenants can sell fairly quickly, most commercial properties have a market time of 6-12 months. The main reason for this is that there aren’t nearly as many buyers in the market for commercial properties. While many people can get into a residential investment with minimal capital requirements, most commercial deals will require a buyer who has a significant amount of liquid capital available. Another reason is that financing a commercial property can be a lengthy and complicated process. Just as commercial investments have a higher risk for the investor, they also carry more risk for the lender.
Investing in commercial real estate can provide some extraordinary gains. Buying the right property in the right location at the right time has made many investors millions and millions of dollars. However, many deals that have looked like “no brainers” have sent investors right into bankruptcy. Just like any type of investment, it’s extremely important to do the research, have the capital available if things go wrong, and work with the right professionals to get the deal done right.