Advantages and Disadvantage of Commercial Real Estate
Any type of real estate, whether it is commercial or residential, can be a good investment opportunity. For your money, commercial properties typically offer more financial reward than residential properties (such as rental apartments) but there also can be more risks.
Recognizing the full advantages and disadvantages of investing in commercial properties is crucial so that you make the investment decision that is right for you.
What is a ‘Commercial property?’
Commercial properties maybe refer to as:
- Retail building
- Office building
- Industrial building
- Apartment building
- Mall buildings
- Mixed use building, where the property may have a mixture of offices, retail and apartment.
There are slight differences to managing each of these types of properties. To give you a general overview of what it is like investing in commercial property, let us examine the advantages and dis-advantages of investing in a single-story commercial retail building, such as a mall.
Income potential – the best reason is of course the earing potential. Commercial properties generally have an annual return off the purchase price between 6%-8% depending on the location.
Professional relationships. Small business owners generally take pride in their businesses and want to protect their livelihood. Owners of commercial properties are usually not individuals, but LLCs, and operate the property as a business. As such, the landlord and tenant have more of a business-to-business customer relationship, which helps keep interactions professional and courteous.
Public eye. Retail tenants have a vested interest in maintaining their store and storefront, because if they do not, it will affect their business. As a result, commercial tenants and landlords’ interests are united, which helps the landlord maintain and improve the quality of the property, and ultimately, the value of their investment.
More objective price evaluations. It is often easier to evaluate the property prices of commercial property because you can request the current owner’s income statement and determine what the price should be based on that. If the seller is using a knowledgeable broker, the asking price should be set at a price where an investor can earn the area’s prevailing cap rate for the commercial property type, they are looking at (retail, office, industrial, etc.).
Requirement structure. Investing in a commercial property have fundamentally a few basic conditions that investors look for:
- A good return on investment- their investment is giving them a healthy return.
- Location – the location it built up family homes and other amenities to compliment your concept.
- Visibility – it can be visually seen from a distance.
- Accessibility – customers can easily reach the unit.
- Target audience and demographic- certain area have an influx of a particular nationally/age which may be advantageous to a client concept.
- Parking facilities – customers have the option to park within close proximity of the unit.
Time commitment. If you own a commercial retail building with several tenants, you have more to manage than you do with a residential investment. You cannot be an absentee landlord and maximize the return on your investment.
With commercial, you are likely dealing with multiple leases, tenants’ issues, and annual maintenances cost adjustment requirements. In a nutshell, you have more to manage; and just as your tenants must worry about the public eye, you do as well.
Professional help required. If you are a do-it-yourselfer, you better be licensed if you are going to handle the maintenance issues at a commercial property. The likelihood is you will not be prepared to handle maintenance issues yourself and you will need to hire someone to help with emergencies and repairs. While this added cost is not ideal, you will need to add it on to your set of expenses to properly care for the property. Remember to factor in property management expenses when evaluating the price to pay for a commercial investment property.
Property management companies can charge on average between 5-10% of rent revenues for their services, which include lease administration. It is critical you evaluate beforehand if you want to manage leasing and the relationships yourself, or if you want to outsource those responsibilities.
Long hours of operation. Some businesses usually go home at a reasonable hour at night, barring emergency calls at night for break-ins or fire alarms, you should be able to rest at night without having to worry about receiving a midnight call because a tenant wants repairs or has lost a key. For commercial properties it is also more likely you will have an alarm monitoring service so that if anything does happen at night, your alarm company will notify the proper authorities.
However, the late-night retail and F & B may have a toil on your social/family life. In other words, you work when they work.
Bigger initial investment. Acquiring a commercial property typically requires more capital up front than acquiring a residential rental in the same area, so it is often more difficult to get your foot in the door; however, once you have acquired a commercial property, you can expect some large capital expenditures to follow. Your property might be humming along nicely for several months and wham, here comes a AED10,000 bill to address a major repair. With more customers there are more facilities to maintain and therefore more costs. What you hope is that the gains in revenue outweigh the gains in costs, to support purchasing a commercial property over a residential one.
More risks. Properties intended for commercial use have more public visitors and therefore have more people on the property each day that can get hurt or do something to damage your property. People can slip on wet floors, items misplace on shelves can fall, outside wall get damages Incidents like these can occur anywhere, but chances of experiencing something like these events go up when investing in commercial properties. If you are risk adverse, you may want to look more closely at putting your money in residential properties.
Number one advice “see professional” guidance, look at all the pros and cons, always have financial reserves (for the unexpected) do you due diligence.