Any investor can find commercial property appealing. Before investing commercial property first-time investors tend to think that only big investors or business class invest in commercial properties. This isn’t true. Investors are also confused about the difference between Commercial and Residential properties – which is a better option for income?
Residential investment properties include single-family or multi-family houses, condos and apartments that people rent for their own use (not commercial).
Any type of property, whether residential or commercial, is a great investment. In 2019, the private equity investment in commercial assets is high, resulting in increased investment. Commercial real estate, especially office properties, is the most successful real estate asset class.
You should know some things about commercial property before investing in it.
Tips on Commercial Real Estate Investing
Location:
Rent and capital appreciation are two ways to get a return on your commercial investment. The location of the property will determine the return on both. When investing, look for areas with a vacancy rate of less than five percent. This means that the location’s supply is under control and tenants are less likely than usual to leave the area, which leads to higher rents and capital appreciation. The tenants will have many options to negotiate rent and move if the vacancy rate is high.
Quality:
The building with the better quality is likely to be rented out first if two similar buildings are located in the same area. A better-quality place will attract more investors, which will lead to better tenant retention and capital appreciation.
Multinational tenants are always willing to pay more for a good place. Look for buildings with more elevators, a better view, a higher ceiling height, or certificates such as platinum ratings, LEED Gold. The high-quality properties are also more liquid, and can be sold for a higher price.
Supply vs Demand:
Each city has its own micro-market. Each micro-market is categorized by the number of completed and leased offices, as well as upcoming supply.
Rents and prices will drop if annual supply exceeds historical demand in the next two to three years. Both old and new properties will be affected by a high supply. Rents can be renegotiated in old buildings and there are escalation provisions. In new buildings rents will be lower because tenants have many options.
Interior Fit-outs:
It is important for investors to be aware of the interior fittings and finishes in the property. When an office is finished, it comes with a bare shell. This means that the interiors are unfurnished, there is no ventilation or air conditioning, and there is no plumbing, lighting, or other amenities. Tenants are responsible for all the work, including flooring, air conditioning and ceilings, wiring, conference rooms, interior cabins etc.
Some tenants pay extra for the developer to fit out their apartments, while others do it themselves.
Fit-out is divided into two categories: Category B and category A .
The tenant can choose to fit out their own space, such as installing suspended ceilings, electrical, mechanical, and fire systems. Category B, on the other hand, is about developing your internal space in a way that suits you and your business. Category B includes private offices as well as Reception Areas, Meeting Rooms and Conference Spaces, Flooring Finishes, Doors, Furniture Installation and more.
Costs vary from one region to another and by space. For a rough estimate, you should consider Fit Out Costs, along with installation costs, training costs, and infrastructure costs. You can budget between 5 and 10 percent of total project costs.
Tenant quality:
Avoid smaller, unknown companies and always look for multinationals. These tenants are more likely to pay their rent on time and pay a larger deposit. They also tend to stay longer, increasing the value of your property.
Lease Structure:
The lease structure for commercial and residential properties is different. The lease structure for commercial properties is 3+3+3 and 5+5+5, which means that the lease will be 9 or 15 year leases with 3 or 5-year escalation periods. The lease is one-sided. A tenant can leave at any time of day and the landlord is not allowed to ask them to stay for the duration of the lease. There is also a lock-in period, during which the tenant cannot leave the property.
When analyzing an investment, it’s important to know how the lease has been structured and what risks are involved. It is usually best for an investor to have a long lock-in period.
Patience and patience is the key to success:
In comparison with residential investment, the process is slower. The entire process takes longer, from renovations to building out to the leasing and finding of new tenants. Everything takes more time. Be patient when investing in commercial property.
Security Deposit:
Security deposits in commercial properties can range from 10 to 12 months of rent. Be cautious when a landlord offers a security deposit that is less than 6 months. This could indicate that the tenant has cash flow problems or wants a short-term option. Startups usually ask for lower deposits and shorter lock in periods.
Diversification and Risk Reduction:
Diversifying your portfolio of commercial properties is the best method to reduce risk and maximize the potential returns on your commercial income properties. Investing all of your savings into one property can be risky. Rent will cease if the tenant vacates, but property taxes still need to be paid.
It is therefore recommended that you invest in several properties in different cities to reduce the variance of income.
