Countless people have had success over the years investing in residential real estate, and often several factors precede such a decision, including appreciation, supply, and demand, plus return on investment. Similarly, investing in commercial real estate takes these variables into consideration and offers the potential for higher returns. Many real estate investment experts see current market conditions as an ideal time to start investing in commercial property and land.
Perhaps the most obvious reason people consider any type of real estate investment is for profit. Commercial building owners have several advantages they can take advantage of to help ensure appreciation. First, business appreciation is only taxed when sold, allowing the owner to take advantage of certain tax laws. Also, since commercial property owners can complete a 1031 Exchange and avoid paying taxes when the property is sold, as long as there is continued investment in real estate, the gains are protected on the sale. Third, there are a number of things a commercial property owner can do to increase value, such as increasing tenants’ rent or reducing operating costs. Finally, by taking advantage of a triple net lease, commercial property investors can often get tenants to pay for building maintenance costs.
Too often, residential property owners find themselves paying part of the mortgage due to a tenant (usually the only one) not making a payment or due to excessive maintenance costs. However, with commercial properties this rarely happens. The reason for this is that most commercial real estate loans are tied to what is known as a debt service coverage ratio. This relationship requires that a property’s net operating income be higher than loan payments, ensuring both security for the bank and profits for the owner.
Another attractive feature of investing in commercial real estate is that it allows one to diversify their risk (critical investment advice worth paying attention to). Suppose you have a shopping center with space for 10 tenants and all the spaces are rented, if one of the businesses goes under, the owner of the shopping center will only lose one-tenth of his income. If that same investor owned a single-family home and its tenant moved out, that investor would lose all of their source of income from that property.
Commercial real estate is a big barrier to inflation; allowing the investor to actually make money. One reason is that rent increases with inflation and so does the value of the property. If, for example, the rent goes up, the property’s value correlates. Inflation also raises construction costs for new properties.
Investing in commercial properties provides the investor with a long-term source of income and many tax benefits. It also allows greater protection in light of diversification and allows inflation to benefit the investor. Considered by most to be a solid and safe type of investment, investors should consider adding commercial real estate to their portfolios.
