Why You Should Invest in Commercial Real Estate OVER Residential
Single-family investments are the worst path you can take in real estate.
Hear me out.
Sure, buying a single-family home is better than not buying real estate at all. In fact, I still feel that residential real estate is better than any other investment vehicle you can choose.
But that’s not what we’re here to discuss.
I’m going to show you why you should be investing in commercial real estate instead of residential properties.
I know - the cost of entry is lower on the residential side and very attainable for most first-time investors. The process is also not very overwhelming, for the most part.
In fact, over 60% of Americans will own a home during their lifetime, so most of you will have experience with purchasing a home. You save up, you finally buy that dream home, and after years and years of living there, you buy a new home and rent the old one out.
Residential real estate is really just a glorified bank account.
Commercial real estate, on the other hand, offers investors a more diversified, balanced, and scalable approach to real estate investing. Building a portfolio of passive commercial real estate investments is, hands down, the path to take.
And there are many different paths you can take to become a passive real estate investor.
Here are 5 reasons you should forget about residential investing:
Higher Quality Tenants
I’d take on a business rather than an individual as a tenant every time.
Sure, you might be able to find high quality residential tenants for your single-family investment. But they’re still an individual.
Businesses can bring higher credit, often national or regional, and these leases will usually be backed by the company with a personal guaranty from the partner or partners in the business. You have a much stronger safety net there.
And, they are more likely to respect the property more. A business’ location is their image, especially if they’re hosting clients at their space, so it’s very important to them to maintain the quality of the real estate.
Commercial real estate is also ungoverned by fair housing laws.
When leasing residential real estate, you have to be very cautious to not violate any aspect of the Fair Housing Act.
However, in commercial real estate, you can ask your tenants just about anything you need in order to properly vet them for your space. You can request tax returns, personal financial statements, bank statements, profit & loss reports, balance sheets - and that’s just the tip of the iceberg.
If you’re not thrilled by what you’re seeing, you can refuse to lease the space to them without having to worry about legal repercussions.
Fewer Expenses as a landlord
It’s very rare that your residential tenant will cover your property taxes, insurance, and building maintenance.
In commercial real estate, however, it’s rather commonplace, depending on the type of property and lease structure.
Retail, along with some industrial and office properties, often have what’s called a Triple Net (NNN) lease.
And while many investors have a different definition of what NNN actually means, they are an extremely valuable asset for commercial real estate investors.
In a triple net lease scenario, the property owner is not responsible for paying any expenses, such as taxes, insurance, utilities, etc. on the property.
If the lease is Absolute Net, the tenant will also take 100% responsibility for maintaining the building structure, including roof and foundation.
Larger corporations, such as Starbucks, will sign this type of lease so that they may maintain their brand’s look and feel without having to rely on a landlord to make those decisions.
Landlords will solely be responsible for paying their mortgage on the property.
Talk about a win for the investor.
Forced Appreciation
One of the biggest differences between residential and commercial real estate is how property values are determined.
Residential real estate is largely influenced by comparable properties, so your single-family investment will only go up in value as properties nearby sell for a higher price.
And that can a grind when residential appreciation is historically 3-5%.
Commercial real estate, on the other hand, is directly valued on the property’s revenue.
Simply put, the higher the cash flow a commercial property generates, the higher the property’s value will be.
By curating the right tenants and leases, you can create stronger cash flow and higher values.
better returns
Commercial real estate can be more on the risky side, and “with greater risk comes greater reward.”
Compared to typical returns from residential investments, cash flow and appreciation are far more attractive in commercial real estate.
Businesses can afford to pay much higher rents than individuals and sign longer term leases, so less consistent turnover for commercial investors.
The stock market offers an average annual return of around 10%, slightly below that expected of residential real estate, while REITs, one of your options as a passive real estate investment, have averaged 12.99% annual returns, according to the MSCI U.S. REIT Index.
Longer Leases
Residential lease terms tend to be in the 6-12 month range, while commercial leases can be 3, 5, or 10+ years.
As an investor, commercial property can give you lower turnover costs and vacancy rates.
These long lease terms give you more reliable passive income and less of a headache by not having to market a property from year to year.
Sure, it’s also possible that you could end up with less than desirable tenants for extended periods of time, but if you properly vet your incoming tenants with lease applications, financials, and background checks, you can avoid these long-term issues.
Share This Article:
About The Author:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors as a board member for the Real Estate Investors of Nashville. Learn more at www.TylerCauble.com
Cap Rates are an extremely important factor in the buying and selling of commercial real estate. If you’re investing, this article will give you a strong grasp on this concept! And check out our commercial real estate cap rate calculator, too.