Is Commercial Real Estate A Wise Move?
August 20, 2021
For those attempting to grow their wealth long term, save for retirement, or achieve a greater level of financial freedom, real estate, whether residential or commercial, offers strong potential to get ahead financially. Real estate is a great way to diversify your financial portfolio and can offer solid tax benefits, but when it comes to investing in residential versus commercial properties, knowing which strategies are right for your goals can be a real challenge. If you’re committed to long-term growth with potentially higher returns, the benefits of commercial real estate may be a great fit for you.
Like any investment, real estate comes with its own set of rewards and risks, and commercial real estate differs significantly from residential in its strategies and financing methods. Understanding the below pros and cons of commercial real estate will hopefully help guide you to decide if it’s a potential good fit for your investment strategy.
What is Commercial Real Estate?
Commercial real estate is a property with five or more units used specifically for business or to generate income. This may include multifamily housing, hotels, offices, retail space, restaurants, industrial warehouses, healthcare facilities, or multi-use spaces. While in a residential property, it is families or individuals which are the typical tenants; in commercial properties, it is businesses and corporations. It is worth noting that depending on their location, commercial properties may be subject to more complex zoning ordinances than residential units.
Commercial Real Estate Pros
Commercial real estate offers investors a specific set of benefits and opportunities that differ from residential properties. Does that make commercial real estate a better investment? It depends on what you’re looking to achieve, but consider the following advantages to commercial real estate:
Commercial real estate is entitled to certain tax breaks that can drastically reduce the tax burden for commercial properties. These tax breaks may include deductions for mortgage interest, depreciation, and non-mortgage-related expenses such as maintenance, renovations, or applicable association fees. Additionally, you may be able to avoid capital gains tax when you sell your commercial property if you reinvest those profits into another building or asset. It is worth consulting with a tax professional to assist you in navigating the finer points of using an exchange strategy.
Owners of residential properties often invest a considerable amount of time and effort in vetting high quality tenants who can be trusted to care for the property. Commercial tenants are businesses or corporations who have a vested interest in maintaining a professional public image and are thus more likely to take the care and maintenance of the property seriously to protect their business and their brand overall. The relationship between a business leasing commercial space and the property owner tends to be a more professional type of relationship.
Commercial Real Estate Cons
Professional Services Required
Managing one or more commercial properties each with multiple tenants is similar to running a small business. There’s more to manage, more maintenance, and more public safety concerns. A professional management company is likely needed in order to stay on top of issues and keep things running smoothly.
Commercial zoning has multiple categories, and regulations tend to be more complex than residential zoning requirements. A solid understanding of local zoning ordinances is needed in order to remain compliant with local laws.
Bigger Upfront Investment
More upfront capital is required to purchase a commercial property, and with it comes bigger maintenance and upkeep costs. Replacing the roof or the HVAC system of commercial property for example is far more costly than the same repairs on a residential property. Having a capital reserve and contingency fund is a must when you own a commercial property.
Getting Started With Commercial Real Estate
Investors who have done their homework and are ready to try the commercial real estate waters should first make sure they find a knowledgeable real estate agent who is experienced in commercial real estate. While the upfront cash investment can be out of reach for some investors, there are some more passive options to investing in commercial real estate without purchasing an entire property. Peer-to-peer real estate allows you to pool your money with other investors and affords the ability to open a portfolio with a much smaller initial investment. Similarly, “Real Estate Investment Trusts” describe a company that invests in a portfolio of real estate projects and distributes earnings to its shareholders. There are several types of REITs: publicly traded, publicly non-traded, and private, each with its own set of requirements. While REITs are a hands-off way to invest in commercial properties, investors usually have less control over the types of properties they are invested in or when they can access their money.
While the high-risk/high-reward nature of commercial real estate might not be right for all investors, remaining open to considering new property types expands your options and could help you reach your long term financial goals.