Any type of property, whether it's 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 or single-family homes, but there also can be more risks.
So, understanding the pros of investing in commercial properties is important so that you make the investment decision that's right for you.
What Is a "Commercial Property?"
Commercial properties might refer to:
- retail buildings
- office buildings
- warehouses
- industrial buildings
- apartment buildings
- "mixed use" buildings, where the property may have a combination of uses, such as retail, office and apartments.
There are nuances to managing each of these types of properties. To paint a general picture, let's examine the pros of investing in a single-story commercial retail building, such as a community "strip mall."
Reasons to Invest in Commercial Property
Here are some of the pros of buying commercial real estate over residential property:
Income potential. The best reason to invest in commercial over residential rentals is the earning potential. Commercial properties typically have an annual return off the purchase price between 6% and 12%, depending on the area, current economy, and external factors (such as a pandemic). That's a much higher range than ordinarily exists for single family home properties (1% to 4% at best).
Professional relationships. Small business owners tend to 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 on the property. Retail tenants have a vested interest in maintaining their store and storefront, because if they don't, it will affect their business. As a result, commercial tenants and property owner interests are aligned, which helps the owner maintain and improve the quality of the property, and ultimately, the value of their investment.
Limited hours of operation. Businesses usually go home at night. In other words, you work when they work. Barring emergency calls at night for break-ins or fire alarms, you should be able to rest 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.
More objective price evaluations. It's often easier to evaluate the prices of commercial property than residential, 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, and so forth). Residential properties are often subject to more emotional pricing. See Evaluating Cap Rate: Is that Residential Real Estate Investment Property Worth It? for more on the subject.
Triple net leases. There are variations to triple net leases, but the basic concept is that you, as the property owner, do not have to pay expenses on the property (as would be the case with residential real estate). The lessee handles all property expenses directly, including real estate taxes. The only expense you'll have to pay is your mortgage. Companies like Walgreens, CVS, and Starbucks typically sign these types of leases, as they want to maintain a look and feel in keeping with their brand, so they manage those costs, which means you as an investor get to have one of the lowest maintenance income producers for your money. Strip malls have a variety of net leases and triple nets are not usually done with smaller businesses, but these lease types are optimal and you can't get them with residential properties. For more on common lease terms, such as net leases, see Commercial Leases: Negotiate the Best Terms and related articles in the Your Business Space & Commercial Lease section of this site.
More flexibility in lease terms. Fewer consumer protection laws govern commercial leases, unlike the dozens of state laws, such as security deposit limits and termination rules, that cover residential real estate. For more on commercial leases, see Nolo's book Negotiate the Best Lease for Your Business, by Janet Portman and Fred Steingold.
