Donald Trump has piled on success after success over the years. Despite the ups and downs of business, he has managed to consistently stay on top—and in the public eye—as a business leader and reality television star. Now, he’s running for President. Although it’s too soon to say how he’ll fare in the blood sport that is American politics, there’s no question regarding his ability to navigate profitable real estate transactions, especially when it comes to commercial properties.
While many investors look to single family and multi-unit properties as the starting point for building their wealth, commercial properties such as retail buildings, warehouses and industrial buildings typically offer greater financial upside. But along with the rewards comes risk. Following is a look at the pros and cons of investing in commercial property.
Solid money-making potential: Commercial property trumps residential rentals when it comes to earning potential. Usually, investors can expect to make an annual return off the purchase price somewhere between 6% and 12%, depending on location. By comparison, single family properties hover between 1% and 4%, at best, according to Nolo.com.
Professional tenants: With residential units, you never know who your renters will be, or how they’ll treat your property once they move in. With commercial properties, the tenants primarily are small business owners and/or LLCs, both of which tend to take pride in the appearance of their locations and handle interactions in a professional manner.
Visibility advantage: When it comes to retail locations, most store owners understand the importance of appearances, since failing to maintain their storefront will drive away business. This alignment of interests between tenant and landlord works to the owner’s advantage, since it is easier to maintain the property and, over time, to boost the value of the investment.
Reasonable hours: Commercial tenants keep normal business hours. With the exception of break-ins and fire alarms, which can be managed by your alarm company, there are very few situations that would prompt a call to the property owner’s home in the middle of the night. That’s not the case for residential property owners, who must contend with after-hours repair calls, or tenants who have lost their keys.
Straightforward valuations: Business owners keep records, so determining value usually is easier with commercial properties because the current owner can supply an income statement from which a reasonable asking price can be determined. By contrast, the value of residential properties may be subject to emotional fluctuations.
Triple net leases: Although they can vary, triple net leases relieve the commercial property owner of the need to pay any expenses on the property. “The lessee handles all property expenses directly, including real estate taxes. The only expense you’ll have to pay is your mortgage,” according to Nolo.com. “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, and 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.”
Negotiator’s advantage: Residential real estate is governed by dozens of state laws aimed at protecting consumers. That’s not the case for commercial property owners, who potentially benefit from greater flexibility in lease terms.
More to manage: Commercial properties require more of a hands-on commitment, and that takes time. If your goal is to be an absentee landlord, commercial real estate may not be the best match for you, given that you’ll be juggling multiple leases, Common Area Maintenance adjustments, maintenance, and public safety issues.
You’re not that handy: Whereas buyers of residential property may be able to offset maintenance costs by doing some of the work themselves, investors in commercial property should plan on hiring someone to manage emergencies and repairs. “While this added cost isn’t ideal, you’ll need to add it on to your set of expenses in order to properly care for the property,” reports Nolo.com. “Remember to factor in property management expenses when evaluating the price to pay for a commercial investment property. Property management companies can charge between 5-10% of rent revenues for their services, which include lease administration. Evaluate beforehand if you want to manage leasing and the relationships yourself, or if you want to outsource those responsibilities.”
More money required: For someone who’s just getting into real estate investing, residential real estate may be preferable because it requires less money to get started. By contrast, commercial properties generally cost more, requiring a greater outlay of cash at purchase, as well as the ability to cover some sizeable capital expenditures on the backend for major repairs and maintenance costs.
A riskier proposition: Commercial properties attract more people, a fact which increases the odds of someone getting hurt on, or damaging, your property. Falls on the ice, pedestrians getting hit by cars in the parking lot, graffiti by vandals, and other acts beyond the owner’s control are common to commercial property. Risk adverse investors may find residential properties less daunting.
Fortunes have been made in both residential and commercial real estate. If you research the opportunities available in your market and consult with professionals before committing capital, you could be the next Donald Trump.