The Top 5 Reasons to Switch From Residential To Commercial Real Estate Investing

Real estate is one of the most financially rewarding investments with great potential for success. When done properly, real estate investors who know how to take a calculated risk can earn themselves a huge profit.

Benzinga · 11/20/2019 22:19

Real estate is one of the most financially rewarding investments with great potential for success. When done properly, real estate investors who know how to take a calculated risk can earn themselves a huge profit. Whether it’s from flipping houses, buying homes as long- or short-term rentals, or leasing commercial property, the many opportunities in the real estate market continuously grow through the years.

Like with any form of investment, real estate investing comes with its own set of risks to consider. However, because real estate is a tangible asset, investors are provided with an extra cushion of protection in the event that the market fluctuates. Properties will still physically exist despite a market correction — and, fortunately, no matter how severely the market crashes, people will still invest in homes and business spaces.

While many opportunities in residential real estate investing exist, many investors opt to take advantage of the benefits that come with investing in commercial real estate. Below are the top five reasons why you should also consider switching from residential to commercial real estate investing:

1. Fewer maintenance issues

Maintenance issues and property damage are only two of the many things causing major stress and headaches to landlords. These are often rampant with residential rentals, especially when tenants are not treating the rental property with utmost care.

With commercial properties, on the other hand, tenants sign longer-term leases. Because commercial properties are intended for business use, tenants are more likely to do their part in keeping the property well-groomed and in good condition, especially when they receive customers on a day-to-day basis. The risk of someone trashing your unit is minimal when compared to a residential property.

2. Increased income security

Investing in commercial real estate through leasing a property is less risky for the owner not only when it comes to property maintenance, but most importantly, by providing increased income security and better cash flow than residential, single-family homes. By becoming an owner of commercial real estate, you have the option to lease your property for a longer-term contract, meaning it would take a few more years before you will need to deal with vacancies when the lease expires and the tenant chooses not to renew the contract.

However, this does not guarantee that your tenant will not terminate the lease before the contract ends. As a commercial property owner, you have the power to require a higher deposit amount which is forfeitable in the event that the tenant needs to pre-terminate the lease.

3. Higher ROI opportunities

Commercial real estate has the potential for a significantly higher return-on-investment (ROI) compared to most residential properties since the lease terms of commercial rental property typically require much higher monthly rents than the average rent of a single-family home. Also, commercial real estate provides the opportunity to open other streams of income from a commercial rental — such as leasing parking spaces for tenants, charging parking fees from customers and visitors, imposing maintenance fees, and much more.

4. It’s easier to increase its value

Another advantage of owning a commercial real estate is stimulating its appreciated value This becomes very useful when you plan to sell the property in the near future. Unlike the assessment of a residential property’s value, which is often based on the average comps of surrounding properties, the value assessment of a commercial real estate is not only determined by the local comps. More importantly, the overall value is based on the total amount of revenue generated by the property.

That being said, you can increase the value of your property by generating more revenue streams – the higher the revenue, the higher the value. This becomes helpful for you as the owner while you are waiting to sell the property because you are still the one who will enjoy the advantages of owning a high revenue-generating property.

5. Option for triple net lease

A triple net lease (NNN) is a lease agreement in which the lessee shall be in charge of paying all property expenses, including building insurance, real estate taxes, and the cost of repairs and maintenance, on top of the rent and utilities. Large companies typically want this kind of arrangement because they have the opportunity to maintain the property according to their brand and have better control over their image.

While the rent charged for this kind of lease arrangement is usually much less compared to a standard lease, you will get to easily figure out how much income you will earn monthly. With this agreement, you eliminate the responsibility to pay for such expenses resulting in less stress for you as the owner.

Things to Consider

Investing in commercial real estate offers many advantages. However, additional considerations include:

Interest Rates

The economy is booming right now and while it’s not going to stop anytime soon, it will be a matter of time before it slows down. Commercial real estate is poised to do well because most businesses need to occupy commercial spaces for their existence and growth. That being said, if interest rates rise over the next several years, commercial real estate will suffer significantly. When these leases expire and rates increase by a couple of points, the entire market may be negatively impacted. Every real estate deal is underwritten by these leases.

Historically, low rates fuel a lot of commercial real estate acquisitions. But as interest rates rise, so will the potential for possible problems down the road. As loans become due and rates balloon, tenants may decide not to renew their leases at all, or at such long terms, exposing the owner to cash flow problems.

Startup Cost

Generally, investing in commercial real estate is less risky than investing in residential real estate. The catch is that commercial real estate requires a lot more money to get involved with as an investor, creating a barrier to entry for the majority of middle-class investors.

Typically, pooling the cash required to acquire commercial properties presents a challenge for the average investor, especially if left to his or her own devices. For this reason, it’s important to recognize that when it comes to investing, there’s strength in numbers. There are a bunch of like-minded investors whom you can work with to pool your money together in order to invest in bigger and better opportunities as they arise.

Know Whom to Work With

If you are new to commercial real estate investing, it’s recommended to work with a mentor who can help you learn the things you need to learn. A knowledgeable mentor will hold your hand to look at the deal with you and help you understand the risk that you are taking. Your mentor will also be able to connect you with a knowledgeable and experienced realtor to help mitigate and avoid headaches— Remember, the stakes are higher in commercial real estate and mistakes are more costly.

A mentor will also help you understand property condition reports and state requirements, because the second you own an asset with environmental issues, the state will come after you and you will become the unhappy owner of a liability.