Investing in commercial real estate is a massive topic that Rock Star has touched on a few times. We focus specifically on investors who put their time and effort into residential real estate. Naturally, however, it makes sense that from time to time the conversation brushes over commercial real estate investing.
Any type of property, whether it’s residential or commercial can offer great financial rewards if investors play their cards right. Although there is a possibility of massive financial success through commercial real estate investing, there are generally more associated risks as well. We did some research and here are common questions you might have when it comes to commercial real estate investing.
Let’s jump right in!
What are the different types of commercial property leases?
Single Net Lease
A single net lease is not as commonly seen in commercial real estate investing. This type of lease gives a minimum amount of risk to the tenant who is paying the properties taxes. This means that the property owner is the one who is responsible for all other expenses like insurance, utilities, even repairs. These tenants of the property tend to pay lower rent due to the fact they’re paying the property tax. However, it is important to remember that even if the tenant is late on a payment, the property owner is still held responsible to make payments.
Double Net Lease
Double net leases are seeing a lot more popularity in commercial real estate compared to single net leases. In this type of lease, tenants pay the rent as well as property taxes and insurance premiums. This type of lease sometimes has lower rent because of the other costs. When it comes to maintenance however, it is still the landlord that is responsible for them.
Triple Net Lease
In this type of lease, other than structural repairs, the landlord is absolved of most risk. The tenant is responsible for the base rent, property taxes, insurance, utilities and maintenance costs. Many triple net leases are long term and can last well over 10 years, while the landlord is still able to increase rent over the years based on the revenue that is generated by the property. These leases are pricey compared to the other two leases. When maintenance costs for the tenants are higher than expected, tenants use this type of lease. To avoid this from happening, the property owners like to use a bondable net lease. This means the lease can’t be terminated before a specified expiration date.
What are the biggest pros and cons of investing in commercial real estate?
Great reasons to start investing in commercial real estate:
You work when they work:
When you own a residential property, there are chances that your tenant can call you in the middle of the night to complain about something going wrong with the property. The upside of owning commercial property is that you would only be working while your tenants are working. Unless there is a break in, it’s unlikely your tenant will call you in the middle of the night.
The possibility of earning a great income:
This is obviously the best reason to start investing in commercial real estate. This type of investing can have an annual return from the purchase price of between 6 – 12%. Although it is important to remember that this is very dependent on the area, commercial real estate investments average higher than the annual return from single-family home investments.
Although we can’t guarantee this all the time, small business owners want to protect their livelihood through their business. This makes cooperating with those leasing out commercial properties operate in a business-to-business type relationship. Additionally, having a bad relationship with the property owner can directly affect the tenants business and storefront appearance, which makes it necessary to keep interactions as pleasant and polite as possible.
Bigger companies tend to sign triple-net leases:
As we discussed earlier in this article, this means the property owner does not have to pay any expenses on their property. The business owners that are leasing the property from the owners are the ones that handle all the property expenses. This is because larger well-known companies like Tim Hortons or Shoppers like to maintain their own individualized look through not only the interior of the store, but the exterior as well. Because they are managing the major costs that come with commercial buildings, the investor reaps the benefits of the lowest maintenance but largest income producing properties.
You will find objective evaluations in terms of price:
We all have seen how residential properties can be priced sometimes only based on emotion. However, when it comes to commercial properties, we have seen much more objective prices. You can evaluate the value of the property by looking at the owner’s income statements. If the prices are set just right, the investor should be able to earn the area’s cap rate for whatever commercial property they own.
The disadvantages of investing in commercial real estate:
You will need to get help from multiple professionals:
There are always investors that refuse help from others, saying they can learn the job and do it themselves. However, when it comes to commercial real estate, you legally need to be licensed to handle maintenance issues. In an emergency scenario when you are likely to hire a professional to help you out, and this can add up. It’s important to take into consideration your skills as well as your availability. Don’t be afraid to outsource to property management companies because it can actually help save a lot of money in the long run.
More to manage:
When you own a residential investment, chances are you are only dealing with one set of tenants. However, when dealing with commercial investments, it’s a lot more common to deal with multiple tenants in the same complex. The investor will likely be responsible for dealing with multiple leases, maintenance costs and generally any issues that emerge.
Larger Initial Costs:
When it comes to the initial costs in commercial real estate investing, you tend to face larger down payments, higher costs for inspections (and environmental assessments), higher mortgage brokers costs, usually higher mortgage rates and larger costs for property managers.
Lots of new investors assume there is more money to be made in commercial real estate investing because they are so much larger than a residential investment, but it’s important to consider how it’s mandatory to pay a 25% down. This means that if you’re looking at a $4 million building, you will need a whopping $1 million to purchase it. Obviously, there are cheaper commercial properties you could purchase, but that 25% down is something to be factored in either way.
More risks involved:
With larger properties comes larger responsibility. That’s the saying, isn’t it? Properties that are intended for commercial use generally have more people going in and out of the complex. This means more liabilities and chances for something to go wrong. People slip in bad weather conditions, a careless driver can hit a pedestrian, there are so many things that can go wrong.
Additionally, retailers are the first ones to be hit during an economic crisis. Because of this, even though there tend to be longer leases in commercial real estate investing, it does not guarantee that there will always be available tenants.
If you consider yourself risk adverse, commercial real estate might not be the best choice for you!
3 pieces of advice for those who are looking to get started in commercial real estate investing?
#1: It’s not what you want, it’s what your market requires
I’m sure you would have a vision as to what kind of businesses you would want for your commercial real estate investment. However, what you want might not line up with what the market is demanding or requires. Make sure you do your research on the most profitable businesses in demand so that you can ensure successful businesses and money in your pocket!
#2: Make sure to have a strong team supporting you
Commercial real estate investing requires interacting with hundreds of different people and an enormous amount of forms to sign. You want to make sure that everything goes as smoothly as possible. This requires having a good team to support you. Having a strong legal team to review your contracts is essential for success in commercial real estate.
#3: Don’t be afraid of big deals
When it comes to commercial real estate investing, each deal can make or break your investing career. Playing it safe can be hard to do in this kind of market. Focus on doing proper research, it helps making big deals seem just a tiny bit smaller to help put you more at ease.
There you have it, the ins and outs of commercial real estate investing! Have any more helpful tips or tricks? Leave it in the comments below. Remember, it’s your life, might as well live it on your terms.