Investing in commercial properties is the secret to success for many of the world’s most wealthy real estate investors. There’s no reason you can’t also build massive, passive cash flow; spread your investment risks; use leverage effectively; and build substantial equity.
Whether you’re investing in office buildings, retail stores, or industrial complexes, commercial property has several real advantages.
No. 1. Higher income potential
Commercial real estate garners a higher rent or lease payment per square foot than residential single-family real estate or even apartments. Therefore, the investor has a better chance of earning more income.
No. 2. Lower vacancy risk
By its very nature, commercial real estate has the advantage of lower vacancy risk, because it always involves two or more units. Unlike single-tenant investments, such as a single-family residential home, the vacancy risk with commercial properties is spread over several units.
For example, one empty office out of 20 is only a 5 percent vacancy. For the commercial real estate investor, compare this 5 percent loss with the financial trauma of a single-family home sitting vacant — in which case the investor experiences the painful and costly loss of 100 percent of his monthly rental income.
No. 3. Less competition
There is less investor competition in commercial real estate because some investors are not comfortable in larger investments, such as office buildings, shopping centers, or industrial complexes.
But remember: Although these types of larger deals are out of many investors’ comfort zones, they don’t need to be out of your reach.
No. 4. More flexible sellers
Perhaps a direct result of the fact that there are fewer investors, the owners of commercial real estate typically are more flexible when selling their properties. Plus, they aren’t as emotional as people selling their homes; the sale is simply a business decision.
And because they’re in a business frame of mind, the sellers are more likely to understand and agree to a buyer’s request for 100 percent seller financing; partial seller carryback financing, such as a second mortgage; or second trust deed behind an institutional lender’s first lien. Note: In
No. 5. Depreciation tax shelter
Investing in and holding onto commercial real estate provides you a significant tax shelter through the depreciation of the building and improvements. The depreciation write-off allowed by the IRS, and most states, shelters your new passive income.
No. 6. Expenses paid by tenants
In many commercial properties the tenants pay all the building’s operating expenses. This is especially true in triple net leases, which are common in the commercial industry. In addition to paying the base monthly lease payment, the lessee also pays his or her pro-rata portion of the entire property’s expenses, real estate taxes, property insurance, and maintenance.
Plus, most retail leases include a provision indicating that the landlord receives a percentage of the retail establishment’s sales — or a “percentage rent” bonus. For example, the tenant will pay a base monthly lease payment and the landlord will get a bonus if sales exceed a specified number.
No. 7. Equity buildup
The tenants’ lease payments provide you, the owner, with the cash to make the mortgage payments, which results in a nice growth of equity over time.
No. 8. Solid economic value
You can purchase a stable cash-flowing property today for less than it would cost you to construct the exact same commercial building, in the same neighborhood. Because most existing commercial properties can be purchased for less than their replacement cost, or the cost to build them new, they provide solid economic value. The economics of commercial real estate are based on the property’s historically documented net operating income (NOI). NOI is the adjusted gross income — or scheduled rent minus vacancies — minus the property’s operating expenses, excluding the debt service.
No. 9. Massive leverage
With commercial real estate, you get financial leverage combined with long-term, fixed-rate institutional debt. Other possibilities include 100 percent seller financing or institutional financing combined with partial seller financing.
No. 10. Long-term capital appreciation
Holding on to multi-unit or commercial properties over the long term will provide you with possible capital appreciation and increased cash flow, as a result of higher rental rates over time. The increased cash flow can lead to long-term massive, passive income, with appreciation as the frosting on the cake.
Howard Edward Haller, Ph.D.
