What is commercial real estate anyway?
I read an interesting article in the Edmonton Journal about the commercial real estate market facing uncertain times. The link to the article is below. To be honest, until recently I really didn’t know what commercial real estate was. I had mostly invested in rental houses, and duplexes which is what I considered to be ‘residential’ and when I moved up to apartment blocks one needed a ‘commercial’ mortgage. I had assumed that apartment buildings meant commercial, when in fact by and large they are still considered residential. My next question is why do more people not invest in commercial vs. residential? After all I don’t know anyone who owns a shopping mall, a warehouse, or an office tower. It turns out that each segment is it’s very own niche, however there are varying risk vs. reward with each type. I will try to clarify each type below and my spin on it.
Office can be a one person office, to a multi floor building housing hundreds of employees. The advantage of office is the cash flow is usually very good and if your property is located in a busy area with plenty of parking it is a good thing. The disadvantages are higher tenant turnover that industrial or retail. Office also is very susceptible to downturns in the economy as businesses are usually the first ones impacted, as is the case in Calgary and Edmonton right now.
Industrial leases are medium to long term (5 or more years) and the least management intensive. These properties are often abused and damaged by tenants, and can introduce environmental risks as well.Tenants tend to stay longer due to the high cost to move the business, however these types can be more difficult to sell that retail or apartment buildings. The entry cost to get into industrial is very high as well.
Location and traffic are key to owning retail. Parking and highway access are critical as well, and ideally you would like to have a supermarket as an anchor tenant to generate traffic for the other tenants. The advantage of retail is tenant stability, although the leases can be complex. In general a tenant making money is very reluctant to move. The entry cost is not that great, and one can start with a mixed retail on the ground floor and apartment buildings above.
Apartment buildings are the least risky, hence high loan to value financing is readily available. It is however the most management intensive. A building can be improved and value raised quickly, however a renovated building can be run into the ground in weeks with poor management. The returns on investment are also the lowest, and turnover is very high. It is the most sought after type of real estate by novice investors.
So which is better? each type offers distinct advantages and disadvantages. I have succeeded by being a patient buyer in multifamily over the past few years. Our latest investment Beaumont place is a mixed residential/commercial with 14 apartments on the top and 8 commercial bays below. I love the stability of the commercial portion, in which we have retail and office. The leases are 3 to 5 years which is money in the bank, however the apartments offer quick upside in rental increases every year, or as tenants vacate. One way to invest is through a Real Estate Investment Trust, or REIT. There are many out there, some do just apartments like Boardwalk, while others do office, retail, and/or industrial. Education is the key and finding a mentor who specializes in the type of real estate you would like to invest in. The common theme of all of them is time, it takes time to make money, so get out there and start investing today!!