What types of commercial property should you invest in?
Posted On May 10, 2021
When it comes to commercial real estate investments, investors often want to know what types of properties they should consider investing in. This article looks at 5 groups of properties and the reasons why you should or should not consider them.
1. Earth: People who invest in raw land often expect to buy farmland near commercially-zoned land for a few thousand dollars per acre. They dream that their lot will be re-zoned to commercial in the near future that is worth hundreds of thousands of dollars or more per acre. People who convince you to invest in raw land often try to sell you this dream. While this dream actually happens just like it’s possible to hit the jackpot in Las Vegas, the reality is that most investors lose money or get little return on their land investment. It is a very risky investment since the land generates little or no income. From an income tax point of view, the value of the land is not depreciated, so a depreciation cannot be claimed. Besides that, the interest rate for the land loan is also very high compared to other types of commercial properties. Therefore, each month, you would need to get money to pay the mortgage without charging anything. You should consider investing in land if
– Know how to develop to convert vacant lots into a shopping center.
– Know exactly what you are doing and have a lot of money.
– Own the land of a shopping center (you do not own the buildings).
2. Apartments: It is a management intensive investment, as the turnover rate is high. Leases are short term often one year from month to month. As tenants come and go, you will need to spend money to prepare the unit for occupancy. Apartment renters tend to have a higher late payment history than other renters, as they are more often on a tighter budget. If you don’t like the headaches associated with many tenants, you probably want to stay away from the apartments. The key to a successful apartment investment is
– Control or minimize expenses. This may seem like a trivial task until you see the list of expenses provided by the property manager. These expenses include: advertising, accounting, bank fees (for insufficient funds), capital improvement, coin laundry allowance, cleaning, collection fees, trash removal, insurance, landscaping, legal fees (eviction), maintenance, administration of off-site property, on-site property management, pest control, painting, repairs, sweeping, security, property taxes, utilities and water.
– Invest only in properties in a good location with no deferred maintenance.
– Stay away from rent-controlled areas, for example, Berkeley, Los Angeles.
Otherwise, you may end up getting little cash flow or even having negative cash flow. If high cash flow is one of your investment goals, you may want to steer clear of apartments. In California, if you own an apartment with 16 or more units, you must have a manager on site. This increases expenses even more. In general, apartments are easy to buy and more difficult to sell. There are always many of them in any market. The advantage of apartments is that they tend to have a high occupancy rate, since everyone needs a roof over their heads. Because of this fact, the interest rate on apartments is typically ¼ to ½ percent lower than other commercial properties.
3. Special purpose properties: These are properties designed for a specific business, for example restaurants, gas stations, and hotels / motels.
– Restaurants: Some investors like to invest in branded fast food restaurants such as Burger King, Pizza Hut, Jack In The Box, KFC. These are single tenant properties with long term absolute triple net leases that often require no management responsibilities on the part of the owner. However, the rental income or top rate for these restaurants is typically lower in the 5-7% range. Emerging regional brand restaurants like Johnny Carino’s, Back Yard Burger, Zaxby’s or Tia’s TexMex tend to offer a higher capitalization rate in the 7-8.5% range. However, when you look deeper into the financial statements, they may not yet make a profit. Restaurant operators sell real estate to investors with a higher capitalization rate and rent it for 20 years. In turn, they use the proceeds from the sale to expand their business by building more restaurants. So if you are willing to take higher risks, you will be rewarded with high income with these pop-up restaurants.
– Gas stations: when you buy a gas station, you buy both a property and the gas station business. Most gas stations also have convenience stores and sometimes several auto repair areas. The markup for gasoline is set at 10-20 cents per gallon. [many customers wrongly blame the high gas prices on the innocent gas station operators] but it is quite high for convenience stores. This is considered owner-occupied property that qualifies you for an SBA loan with a minimum 10% down payment. If you don’t plan to get involved in running the gas station, car repair, and convenience store business, you may want to stay away from gas stations, as gasoline is a chemical that could pollute the ground. Once a leak occurs and pollutes the environment, it takes years and a lot of money to clean the floor. You may even be liable for damage from adjacent property owners, as contamination can spread to your properties. It is almost impossible to sell your property as no lender wants to loan buyers the money to buy it.
– Hotels / Motels: Once you buy a hotel / motel, you buy real estate and a business 24 hours a day, 365 days a year. This business requires hard work and marketing skills to fill the rooms. Rooms are worth nothing if they are empty. Business tends to be seasonal and can be hit immediately by economic downturns and political events – for example, September 11. Many of these properties are owned by Indians with the surname Patel, as they seem to work harder and know this business well.
4. Office buildings: These properties are single or multi-story buildings. Older two-story office buildings without elevators tend to have trouble finding tenants on the top floor, as many utility companies may have customers with physical disabilities who cannot climb the stairs.
– Single-tenant buildings: Properties are used as corporate headquarters for large corporations such as Cisco. These large buildings tend to be more sensitive to the economy. Once vacant, it is difficult to find a replacement tenant.
– Multi-tenant buildings: these properties are leased by small businesses, eg real estate, tax accountants. Investors who buy these properties want to spread the investment risks. When a tenant vacates a unit, you lose only a small percentage of rental income.
– High-quality tenants: most of them have good credits, many assets and pay their rent on time when it is due.
– Leases: Office building leases vary from full service [landlords pay property tax, insurance, maintenance and utilities] to NNN [tenants pay property tax, insurance, maintenance and utilities]. The NNN lease is a litmus test as to whether the office building is in high demand from tenants or not.
– Medical buildings: these properties are mainly leased by doctors and dentists. A good medical building should be across the street from a hospital or across the street. This makes it convenient for doctors to come and go between the hospital and their offices. Some investors prefer medical buildings, as medical tenants are very recession-proof.
5. Shopping centers / retailers: These centers are mostly single-story and can accommodate a wide variety of tenants: retail and service businesses, restaurants, doctors, schools, and even churches. As a result, this is the most popular type of commercial property investors are looking for. They are always in high demand as there are more buyers and few sellers.
– Multi-tenant strip: The advantage of this investment is that when a tenant moves out, they only lose a part of the total income while looking for a new tenant. So spread the risks on this property.
– Single tenant building: the advantage is that you only have to work with one tenant. Some of the tenants, for example Costco, Home Deport, Walmart, CVS Pharmacy, sign a 10-20 year lease and guarantee with their corporate assets that they could be worth billions of dollars. This makes your investment very safe.
– High-quality tenants: most of them have good credits, many assets and pay their rent on time when it is due. They often sign long-term leases of 5 to 30 years so you don’t have to worry about finding new tenants every year. They keep their property in good condition and sometimes even spend their own money to make it look better to attract customers to the stores.
– Triple Net Leases (NNN): leases of shopping centers are usually in favor of the lessor. Tenants pay a basic rent and reimburse the landlord for property taxes, insurance, maintenance, and sometimes even property management fees. This takes away a lot of risk as an investor. The NNN lease is in a sense a litmus test as to whether the property is in high demand from tenants or not.
– Land lease: occasionally a shopping center is sold with land lease. When you buy this hub, you only own the upgrade, but not the land underneath. It could be a trophy property, but you should think three times before investing. Once the land lease expires and the owner refuses to extend it, you don’t own anything! So it is easy to buy this center but very difficult to sell.