– By Ashok Kumar, CFO, Creative Choice Group
In terms of real estate, there are two primary categories of property: Residential real estate and commercial real estate. Residential real estate refers to structures that are reserved for human habitation and not business use. Commercial real estate, as its name implies, refers to structures reserved for commerce.
Classes of Commercial Real Estate
Not all commercial properties are created equal. Cities’ zoning requirements often specify for what purposes a tenant or owner may use commercial property. For instance, zoning laws may designate large warehouses for manufacturing, while it may reserve multiroomed buildings for hotels or apartments.
When working with a realtor, you may notice he or she talks about real properties as Class A, Class B, or Class C. The classes refer to the condition and age of a property:
- Class A properties are the best properties in terms of age, quality of infrastructure, aesthetics, and location.
- Class B properties are a step down from Class A properties and are therefore not as pricey to buy or rent as the latter. These buildings are usually older, and investors typically buy them for restoration purposes.
- Class C properties are old, decrepit buildings. They’re generally located in undesirable neighborhoods and need extensive repairs before they become useful again.
Each class of property has its merits, depending on what you intend to use the property.
Managing Commercial Real Estate
Managing commercial real estate is tricky business. Vacancies and tenant turnover can be costly, as commercial spaces must be adapted to meet tenants’ needs. For instance, say a new tenant owns a restaurant, but the previous tenant ran a kickboxing studio. The adaptation would be extensive and costly.
Because of the work involved in minimizing vacancies and turnovers, you might find it beneficial to hire a property manager or property management firm. A property manager is trained in tenant retention, overseeing leases, coordinating property upkeep and marketability, and financing. Property managers also make it their business to educate themselves on the rules and regulations of commercial properties, which vary by county, municipality, state, industry and business size.
Renting Commercial Property
Renting commercial property is not at all, like renting residential real estate. For one, commercial lease rates are calculated by the square foot rather than on a month-by-month or year-by-year basis.
Two, the length of the lease is significantly longer for commercial properties. Leases for residential properties are typically on a month-to-month or year-to-year basis. Commercial leases, however, average between five- and 10-years long.
Finally, the obligations of a commercial tenant are much more broad than those of residential tenants. Before shopping for commercial property to rent, make sure to familiarize yourself with the types of commercial leases, of where there are four primary types:
- Gross Lease: Under this type of lease, the tenant pays rent while the landlord pays for taxes, maintenance, and insurance.
- Single-Net Lease: With this lease, the tenant is responsible for paying property taxes.
- Double-Net Lease: Under a double-net lease, the tenant assumes responsibility of insurance and property taxes.
- Triple-Net Lease: A triple-net lease makes the tenant liable for property taxes, insurance, and maintenance.
Types of Investing
Investing in commercial property can be a lucrative business for those with the right knowledge and cash-flow. However, not everyone can afford commercial real estate. To ensure everyone has a chance to make a living in the commercial real estate market, the industry devised two types of investing strategies: Direct and indirect.
A direct investment occurs when a person becomes landlord through the ownership of the physical property. Individuals best suited for direct investment are those who either have a wealth of industry knowledge or who can hire firms that do. These individuals are also high-net worth.
An indirect investment occurs when a person invests in a property through market securities, such as exchange-traded funds or Real Estate Investment Trusts. This is ideal for those who want to minimize risk and/or don’t have enough capital to directly invest.
Pros and Cons of Commercial Real Estate
The greatest advantage of commercial real estate is, of course, the impressive returns. Because lease rates are high with commercial properties, you stand to earn a decent monthly income in rent alone. The term of commercial leases are long, which also means you can enjoy stability.
In addition to offering a stable and lucrative source of income, commercial property is more apt to appreciate than depreciate. So long as you continue to maintain your property, it’s likely to only increase in value over time.
Commercial real estate does come with a few pitfalls. For one, it requires significant upfront capital to directly invest. Local governments also have stricter regulations for commercial properties, and the cost of renovation is high. In a volatile economy, there’s also the very real possibility that a tenant may leave without any advance notice, thereby leaving your property vacant for months or even years.
Commercial real estate can be a great investment. To increase your odds of success, do your homework and ensure you know all there is to know about investing.