Commercial real estate has plenty of advantages over residential real estate.
Residential real estate is more popular for average real estate investors, but commercial may be the secret for great financial independence.
Why may investing in commercial real estate be better than investing in residential real estate?
We go through these list of reasons below that may have you reconsidering and putting your dollars behind commercial property inside.
1) Commercial Real Estate Has Less Maintenance
If you were to invest, let's say, $10 million and buy residential real estate, let's say of $50,000 houses, you would be able to buy 200 houses. Of course, each house must have at least one bathroom, so you are dealing with at least 200 bathrooms. Many houses have 2 bathrooms, so it could be anywhere from 200-400 bathrooms. Now let's say you were to buy a big office building or airport structure for the $10 million. Let's say the office building was 10 floors and each floor had one large bathroom, maybe consisting of 5 toilets. You would only be dealing with 10 bathrooms. Each bathroom may have 5 toilets, bring the total of toilets to 50 toilets vs the 200-400 if your money was deployed among residential real estate. If you bought a small airport structure, there may be 4 or 5 bathrooms or so, each consisting of 5-6 toilets or so. In other words, we have drastically less maintenance. While each house must have at least one bathroom, among a large commercial real estate, an investor may only have a few lavorities to take care of.
2) Commercial Real Estate Is Usually More Profitable, Much More Profitable
In commercial real estate, it is typical, not always the case, but is typical for an owner and a commercial tenant to go into a triple net lease agreement. This is a lease agreement in which the tenant agrees to pay the property taxes, property insurance, and maintenance, in addition to the base rent decided on. In residential real estate, it is almost exclusively the owner's responsibility to pay the property taxes, insurance, and maintenance. This means that with commercial property, under a triple net lease agreement, you will not have to worry about property taxes increasing, insurance rates going up, and high-cost maintenance, because these are all covered by the tenant. Of course, if these costs increase too much, a tenant may not want to renew, but it isn't you, as the owner, responsibility to pay for these. This means that the rent you collect, other than the debt service you have on the property such as a mortgage, is total profit to you. This is very attractive and is one reason why commercial real estate is so great. Any rent you receive is pure profit other than any debt service you may have. If you bought the property in full cash or have finished paying the mortgage, the rent is 100% profit.
3) Commercial Tenants Normally Earn Their Living on the Premises
This is another huge deal when it comes to commercial property. Tenants of commercial property tend to earn their living on the premises. This means they have an invested interest in keeping up the property, making it look great. Think of grocery stores, pharmaceutical stores, restaurants, malls. They want their place looking great for customers. This is not necessarily the case for residential tenants. We've all heard stories of tenants punching a hole in the wall and calling up the landlord and saying, 'There's a hole in the wall. Come and fix it.' With commercial real estate, the chances of a business owner punching a hole in the wall for a place that he needs beautiful for customers every day to attract them is, let's say, relatively slim. It basically doesn't happen. It happens more than frequently with residential tenants, especially in the not-so-good areas. But with commercial tenants needing the place to look good to attract business, there is a great chance the premises, your property, will be kept in tip-top shape.
4) Commercial Leases Tend to Be For Longer, Much Longer
Commercial leases can last very long periods of time, such as 10 or even 15 years. Once a commercial tenant comes into a property, assuming business is good, they want to stay there. We all know of a CVS pharmacy that has been there for the last 10-15 years. In the residential world, leases tend to be for much shorter periods of time, such as 6 months to 1 year. Sometimes, leases can be 2 years, though the most average is probably 1 year. And even that is a long time to have a tenant. In the commercial world, it is normal to have 5-year, 10-year, 15-year leases. This means that you're set for the next 15 years upon getting a tenant. You willl have your property taxes, insurance, and maintenance paid for by your tenant and collect a base rent.
5) Easier to Evict a Defaulting Tenant
We've all heard stories of a tenant that was unable to pay or just did pay his or her rent and then went on to stay on the property for 3 months, 6 months, even a full year rent-free, while the landlord has to pay expensive fees battling this tenant and upcoming his/her mortgage. This is especially true with blue states, such as New York, New Jersey, and California. These states tend to favor the tenant, arguing that everyone needs a place to stay. With commercial property, this is virtually unheard of. The laws are much stricter with commercial property. In many parts around the world, it is allowed for the commercial owner to change all the locks of the facility and seize whatever inventory the owner has to recoup back some or all of the missed payments. This cannot be done with residential properties. Because of all of this, if a person has a residential mortage payment and a commercial lease agreement, s/he tends to pay the commercial lease payment over the residential payment due to these strict rules.
6) Improvements on Property Leads to Increase in Rent Payments
Another great thing about commercial properties is that in most commercial lease agreements, the tenant can ask the landlord to make improvements to the facility, as needed or as requested. If the landlord agrees to make and pay for these changes, the tenant agrees to buy an increased rent payment in accordance with the new appraisal of the property. So if the landlord spends $100,000 on the property and the value of the property increases by $200,000, the tenant agrees to pay whatever interest s/he was paying with that $200,000 increase. Improvements directly lead to higher rent collections. And if that improvement was deemed necessary, such as a deteriorating wall or something, then the landlord can label that as a repair, which is tax deductible. With residential property leases, it is not usually in the clause that improvements in the property will lead to increased rents.
Much thanks to Dolf de Roos, who frequently talks about the advantages of commerical real estate over residential. Many of the points in this article were brought forth from him.
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