Owning and renting commercial properties as an investment can be more challenging than owning other types of rental real estate, however, it can also be one of the most lucrative investments if done correctly. Especially with household names like Starbucks and McDonalds as tenants. Below we take a deep dive into everything you need to know about commercial rental properties.
Table of contents
- Commercial Rental Property Definition
- Types of Commercial Properties
- Commercial Real Estate Classifications
- Commercial Real Estate Tenants
- Commercial Rental Property News
- Buying, Selling and Leasing Commercial Real Estate
- Where to Buy, Sell and Rent Commercial Real Estate Online
- Pros and Cons of Investing in Commercial Property?
- Types of Commercial Real Estate Ownership
- Managing Commercial Rental Properties
- Financing Commercial Real Estate
- Explore Other Types of Rental Real Estate
Commercial Rental Property Definition
Commercial real estate (CRE) is property (i.e. buildings and land) that is used solely for profit-generating business activities and often leased to commercial tenants for solely business purposes.
Types of Commercial Properties
Commercial real estate is a broad and widely used term, but within this asset class are several types of unique sub-classes that each have their own special characteristics. We explore the most common types of commercial properties below:
Buildings where administrative work usually takes place. These often include spaces for Medical Centers and Professional Services (Lawyers/Accountants).
Multifamily apartments are considered “Commercial” if they have five or more residential units and sometimes get into the 100’s of units.
Buildings where the property may have a combination of uses, such as retail, office and apartments.
Plots of land ranging in sizes from small to very large and also type depending on location such as agricultural outside of metropolitan cities, and infill land within urban cities..
Public facing storefronts such as shopping Centers, Malls (both indoor & outdoor), Neighborhood Plazas, Strip-Malls, and In-line retail in commercial corridors.
Often large buildings used for warehousing, manufacturing, and any other type of industrial economic use
These properties primarily serve travelers and include hotels, motels, lodges, cabins, hostels, and any other type of property for overnight stays.
Examples of special purpose properties include self storage, amusement parks, bowling alleys, parking lots, stadiums, theaters, zoos, and much more.
Commercial Real Estate Classifications
Commercial real estate is a diverse sector that offers investors opportunities to generate income through various property types, such as office buildings, retail centers, and industrial facilities. To better evaluate and compare the investment potential of these assets, commercial properties are often classified into three categories: Class A, Class B, and Class C. Each class is distinguished by factors like location, building quality, age, and tenant profiles, enabling investors to make informed decisions that align with their risk tolerance, investment objectives, and management preferences.
Commercial Real Estate Tenants
Commercial real estate tenants play a critical role in shaping the success and profitability of investment properties, as their occupancy directly impacts rental income, property value, and overall return on investment. Tenants in commercial real estate come from diverse backgrounds, industries, and financial standing, each presenting unique opportunities and challenges for property owners and investors. By understanding the intricacies and dynamics of various tenant types, such as mom and pop businesses, seasonal occupants, and credit tenants, landlords can make informed decisions that contribute to the long-term success of their commercial real estate ventures.
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Buying, Selling and Leasing Commercial Real Estate
At the core of commercial real estate is the buying, selling, and leasing process. Buying a commercial property can be an exciting endeavor to grow your investment portfolio. Selling a piece of commercial real estate can also unlock new levels of growth and release tied-up capital in a property. Leasing is the most important component of commercial rental real estate, as it’s the engine that generates consistent cash flow.
Where to Buy, Sell and Rent Commercial Real Estate Online
Commercial real estate listing websites across the internet attract millions of visitors every year and streamline the buying, selling, and renting process. Commercial property investors and tenants use these platforms to easily find available properties in almost any market. Those looking to sell or lease commercial properties also benefit from these platforms by getting their listings in front of countless potential buyers and tenants.
Pros and Cons of Investing in Commercial Property?
There are many factors to consider when determining whether or not to invest in rental real estate, specifically commercial rental properties. The following is a comprehensive list of the pros and cons you need to know before investing in commercial rental properties.
Pros of Commercial Investing
- Greater Income Potential – More units equal more opportunities to generate more revenue. Commercial properties also allow for alternative revenue sources such as advertising space (Billboards), rooftop cellular sites, parking lot rentals, vending & ATM machine rent, and more.
- Longer Tenancy – Commercial tenants normally sign multi-year leases ranging from 3-5 Years and sometimes have an “option” to add on additional years. This gives landlords greater long term predictability for property cash flow and stability.
- Less Maintenance Responsibilities – Most commercial leases require that tenants handle more maintenance responsibilities. A lease type called “Triple net – NNN” is the most ideal for Landlords, in which tenants are responsible for 100% of maintenance (with a few exceptions).
- Professional Relationships – Commercial tenants are generally business owners whose best interest is to keep the property welcoming and in good shape. These interests generally align with the owners, resulting in a well taken care of property.
- More Flexibility of Lease Terms – Since most businesses are unique, most commercial leases are tailored to each tenant. Maybe the tenant is a laundromat who uses a lot of water. In this case, you could write the lease so that this one tenant pays for the entire property’s water bill.
Cons of Commercial Investing
- Longer Vacancy Time – While apartment seekers are forever plentiful, renting a commercial space usually takes longer to find the perfect tenant. Depending on the market and property, this process can range from several months to several years.
- Greater Overhead Costs – Business tenants expect a professional interaction with their landlord. As such, there are additional costs to operate commercial properties such as a property management office, parking lot cleaning, admin personnel, licensing & permit fees, and more.
- Bigger Investment – The typical down payment to acquire a piece of commercial rental real estate is much greater than a standard home. The down payment for commercial properties can range from 20-50% and loan interest rates for commercial properties are usually higher than other rental property types.
- Professional Services – Since there is more at stake in commercial rentals, it is always best practice to avoid DIY (Do it Yourself) and use professionals. These can range from commercial real estate brokers for vacancy leasing, to licensed and bonded tradesmen for repairs.
- Greater Liability – Commercial rental real estate is generally intended for public use. With greater use of people regularly interacting with the property, also comes greater probability for someone to get hurt or damage the property (both intentionally or unintentionally).
Types of Commercial Real Estate Ownership
Since commercial real estate is treated as a business, legal ownership can take many different forms. The most common types of ownership structures for commercial properties are Sole Ownership, Partnerships, Joint Venture (JV) , Corporation, Limited Liability Company (LLC) , and Trusts. Choosing the right form of property ownership is extremely important for reasons such as liability protection, controlling tax liabilities, and staying on top of administrative requirements.
Managing Commercial Rental Properties
How to manage a commercial property depends a lot on the size and type of property. If you were to own a single-tenant retail building with a long term triple net (NNN) lease and are knowledgeable about commercial real estate best practices, then maybe self-managing could be an option. Conversely, if you own a 10-unit retail shopping center with a mix of national and local mom-and-pop tenants, then hiring a third-party management company might be a better option.
Financing Commercial Real Estate
Commercial rental property financing by far has a higher learning curve when compared to all other types of rental real estate loans. However, once understood and establishing an experienced track record, can unlock the greatest source of capital for a real estate investor. Commercial property loans place great scrutiny on the property, deal, and experience of the investor. As such, commercial lenders look at factors such as Loan to Value (LTV) ratio, which is how much equity the borrower has in the property, and Debt-Service Coverage Ratio (DSCR) which is the property’s ability to pay back the loan.