Investing in Commercial Real Estate

• Hyder A.
• Post published:July 19, 2021
• Reading time:7 mins read

Growing up watching HGTV’s hit shows Property Brothers, Income Property, and Fixer Upper, I always wanted to own multiple properties. HGTV stands for Home and Garden Television. Unfortunately that means they don’t cover commercial properties. The only TV show I know of that somewhat covers commercial properties is CNBC’s The Profit, hosted by Marcus Lemonis. In the Profit, Marcus invests in several troubled businesses and helps turn them around, whether it’s a restaurant, e-commerce, or manufacturing. There are 4 categories of commercial investment properties you can invest in. These include Multi-Family, Office, Retail, and Industrial. Industrial and Office Spaces typically lease for 5 or 10 year contracts while retail leases range from 1 to 5 and multi-family renew leases annually. In general, the larger the property the longer the lease.

Multi-Family

Multi-Family commercial properties are most popular with real estate investors who invest in residential properties because it is familiar. The commercial side differs in that multi-family can be an entire apartment building, condo complex, or senior living community. While the earning potential is high, it typically requires having a property manager and a maintenance crew on staff along with periodic inspections and more legal liability and responsibility.

Office

In these COVID times, the office category of real estate is suffering. Many companies have switched to tele-work or working from home. Some are downsizing their operations, leaving many office buildings vacant for long periods of time. As an owner of an office space, you have to invest in your space every time to get a new tenant. In most cases, it is up to you to clear the carpet and furniture of your previous tenants. Your new office tenants typically redesign the space and bring in their own office furniture. You need to invest your time and money in giving your new tenants a blank slate. Depending on how you word your contract, you may also need a property manager on staff to take care of building issues. Office buildings are further categorized into classes. Class A is the best as it means you are buying a newer, nice looking office building in a great location. Class B buildings are a little older and more affordable. They may also need some updating. Class C buildings are older than 20 years of age and are usually located in less attractive areas. These are the most affordable office spaces to purchase, but they may need lots of maintenance.

Retail

The Retail category is probably the riskiest at this time. The retail space has greatly suffered from e-commerce and COVID, especially shopping centers and malls. A quick online search using LoopNet for commercial properties for sale yielded very affordable retail listings. You can get into the retail space very easily since it is cheaper than the Office, Multi-Family, and Industrial categories. New businesses are starting off with short 1 year leases because of the uncertainty in the economy. Will their business do well? Will you need to kick them out after 6 months? In this category, you want to do everything you can to support your tenants so you can continue to get paid. That may include free advertising or keeping the property aesthetically pleasing. Everyone is buying everything online. Why drive to a retail store, look for parking, and waste time looking around when you can get 2-day shipping on Amazon?

Industrial

Industrial categories typically do well. They include warehouses, manufacturing, fabrication, storage, and automotive repair. They are broken out into subcategories by zoning and licensing. For example, you need to have the building zones and licensed for manufacturing of goods if you want a tenant who manufactures something. In some cases, you may need a building/property manager and in other cases the tenant will choose to provide their own. In Industrial Buildings, it is usually up to the tenant to modify, upgrade, and maintain the property. As the landlord, you may have to approve certain changes such as the installation of solar panels or the installation or removal of walls, substations, or major utilities. When your tenant’s lease expires and they choose to leave, they are responsible for taking everything with them leaving you with a blank industrial space to offer to the next tenant. This greatly differs from the Retail or office space where it is your responsibility to clean up after the tenant. Industrial Properties lease at lower rates but they also offer lower operational costs and longer leases than the other three commercial property categories.

The Four Types of Commercial Leases

1. A single-net lease requires the tenant to pay for property taxes. This is typical of retail spaces.
2. A double-net lease requires the tenant to pay for both property taxes and insurance. This type of lease is typical of multi-family properties and some retail properties.
3. A triple-net lease requires the tenant to pay for property taxes, insurance, and maintenance. This type of lease is common in the industrial space.
4. A gross lease requires the tenant to pay for rent only while the property owner pays for taxes, insurance, and maintenance. This is typical of an office building.

Managing Your Properties

As I mentioned earlier, many commercial properties may require a full time property or building manager and maintenance crew. In most cases, it is best to go with a commercial management company to handle everything for you. They will find tenants for you, they will market your space, they will help maintain your space, they will respond to tenant requests, and they will understand the specialized rules and zoning requirements of each state, city, county, municipality, or township. The job of these management companies are to maximize your rent while minimizing tenant turnover. The fee? Fees greatly vary depending on your area and the property type. You can expect to pay at least 1 months of rent in addition to a monthly percentage typically falling under 15%. If you know nothing about commercial real estate, a management company is definitely worth your time and money.

Should You Invest?

Commercial properties require a large amount of capital up front. They are high risk high reward investments. Do a quick property search on LoopNet.com and you will find that most good properties are listed for well over $1 million. You can save up the capital and buy a property directly, you can invest in a portion of a commercial property with as little as $500 using FundRise, or you can consider investing in REIT’s (Real-Estate Investment Trusts) and ETF’s (Exchange Traded Funds) through the stock market using free brokerage apps like Webull, M1 Finance, and Robinhood. If you really want to own a property directly by paying the large capital required, you will be rewarded with rents that are larger, more stable, and of a longer term than residential property leases. You may also be rewarded with capital appreciation if you keep the building in good shape. The downsides include needing the specialized knowledge (or hiring someone who knows) of federal, state, and local taxes, zoning requirements, and legalities. A second downside is tenant turnover. If the economy is not doing well, there is a good chance your tenant will break the lease early with little notice. A third downside is how the needs of each tenant may differ. You may need to invest thousands of dollars to address the needs of each new tenant.

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