The Pros and Cons of Investment Real Estate - Part 1

September 27, 2019
Small business owners always have a lot to handle, from cash flow to employee benefits to generating new business. But because small business owners are, by their very nature, entrepreneurial, they tend to always be on the lookout for new opportunities to generate wealth and secure a sound financial future for themselves and their families.
Investing in commercial real estate – retail and office buildings, warehouses, industrial buildings, and mixed use properties – is easily one of the most attractive of those opportunities. It’s important to recognize, though, that investment real estate is not foolproof and it’s definitely not for everyone. Understanding the pros and cons of investing in a commercial property is absolutely essential before any money ever changes hands.
First, let’s examine the positives of investing, starting with income potential. Typically, commercial properties have an annual return off the purchase price of 6-12%. This depends, of course, on a number of factors, most prominently the area in which the property is located. If the property is located in an area undergoing major revitalization – new construction, new retail development, plans for a major attraction such as a sports arena or a town center – an investment can yield a handsome profit. Investments in commercial properties also tend to be more lucrative than residential investments, where the annual return tends to be, at best, 1-4%.
Commercial property prices are relatively easy to evaluate because the current owner’s income statement should be available for the prospective buyer to review. If the seller is using a reputable broker, the asking price usually will be set at a level which enables an investor to earn the area’s prevailing cap rate – the ratio between the net operating income produced by the property and either the original capital cost or the current market value. In other words, commercial properties offer more objective price evaluations than, say, residential properties which are often subject to emotional pricing.
Finally, leases on commercial properties tend to favor property owners. For example, owners generally do not have to pay expenses on the property other than the mortgage. This is because property expenses, including real estate taxes, typically are paid by the tenants. Similarly, commercial properties offer more flexibility in lease terms and are subject to fewer consumer protection laws than residential real estate.
Beyond the pricing benefits, commercial properties offer several other advantages that make them attractive to a small business owner whose main business is still his or her top priority.
High on that list is the fact that commercial properties often have limited hours of operation. That means that – barring an emergency late-night call for a fire alarm going off or a break-in – the property owner won’t have to worry about receiving a 3 a.m. call from a disgruntled tenant complaining about a needed repair. In short, commercial property owners work when their tenants do.
Commercial tenants (and particularly retail tenants) also have a vested interest in maintaining the property. They know that if they don’t, it will impact foot traffic and, ultimately, sales. This means their interests are in perfect alignment with the property owner’s interests, which – for the latter – translates into improvements in both the physical property and the value of the investment.
Finally, owners of commercial properties are typically LLCs which operate the property as a business. That means the owner has a business-to-business (as opposed to a landlord-tenant) relationship with the tenants. This goes a long way toward keeping interactions professional and courteous.
Clearly, investment real estate can be profitable and even enjoyable, but it is not without its cons. Before investing, be sure to examine the downside of investing in commercial property in Part Two of The Pros and Cons of Investment Real Estate. And as always, be sure to contact the business lending experts at Point Breeze Credit Union. They’ll be happy to answer your questions and provide information that will help you decide which options are best for you.