The allure of commercial real estate brings opportunity to many investors, offering a potential steady stream of income with the ability to maximize long-term capital appreciation. While the rewards can be substantial, navigating this dynamic landscape requires a keen understanding of factors that influence profitability.
Return on investment (ROI) serves as a crucial benchmark for evaluating the profitability of any commercial real estate venture, measuring the net gain an investor realizes relative to the initial investment cost. While a baseline ROI of seven percent per year is generally considered good, this figure can fluctuate based on several key factors. The type of property, its location within a specific market, prevailing economic conditions, and individual investment goals, all play a significant role in determining what constitutes a satisfactory return.
As a property owner, financial return is what keeps you in business. We’ll explain the types of commercial real estate you can invest in, important factors that affect profitability, and what to consider when making the decision to buy commercial property.
Types of Commercial Real Estate Investments
Commercial real estate offers a diverse landscape, brimming with investment opportunities. But with this variety comes the challenge of understanding which property type best aligns with your goals.
Multifamily
Residential properties with five or more units, including apartment buildings, student housing complexes, and townhomes, are all considered multifamily commercial real estate. These properties offer a steady stream of income from rent payments and occupancy tends to be relatively stable due to the constant demand for housing.
Office
Office buildings can house businesses of all sizes. The category of “office” is further divided into subcategories like Class A (high-quality buildings in prime locations), Class B (good quality, fully-functional buildings without the high-end finishes of Class A), and Class C (older buildings with lower rents). Office buildings may be quality asset options for a real estate portfolio, but as with everything in real estate, location matters.
Industrial
Industrial properties cater to businesses that need storage, manufacturing, or distribution space. This includes warehouses, light manufacturing facilities, and massive logistics distribution centers.
Retail
Retail properties are filled with direct to consumer business. This includes shopping malls, strip centers, freestanding stores, and even gas stations. The success of retail spaces relies on factors like foot traffic, vehicle traffic, the type of stores and businesses located at the property (and within the immediate area), and overall economic conditions.
Hotel & Hospitality
Hotels, motels, resorts, and convention centers fall under this hotel and hospitality category. Their performance can be variable and hinge on tourism rates, local events, and overall travel trends.
Special Purpose
This category is for properties designed for a specific use, such as healthcare facilities, self-storage facilities, or data centers. The success of a property in this class depends on the demand for that specific purpose in a certain location.
Mixed-Use
Mixed-use developments offer diversity and a community atmosphere, potentially attracting strong tenants. Think of these developments as residential, office, and retail spaces within a single project.
Vacant Land
Undeveloped land with commercial potential can be a worthwhile asset to place capital. This type of property requires careful analysis of future development possibilities and zoning regulations, in addition to the location of the vacant land relative to growth paths.
The Best Commercial Real Estate Investments
As a property owner, several factors are important to consider when determining which commercial real estate investments will provide the most profitability.
Profitability factors to consider include:
- Property type because different property types have inherent risk-reward profiles. Multifamily housing, for example, offers steady income, while something like vacant land involves high initial investment but potentially high returns.
- Location, and here’s why. Properties in thriving markets with high tenant demand and low vacancy rates often generate more rental income for property owners and appreciate in value over time.
- Property condition and amenities because modern, well-maintained properties with desirable amenities (think high-speed internet or secure storage facilities) attract better tenants and potentially command higher rents.
- Lease structure is very important to consider. Something like a triple net lease where the tenant shoulders most expenses—like property taxes, maintenance, and insurance—offers stable income with less management responsibility for you as the owner.
- Market conditions because a strong economic climate with high demand for commercial space generally translates to higher rental rates and property values.
Out of the commercial property options we mentioned above, there are a few that may yield higher profitability over others.
Because of the constant demand for housing and the steady income stream, multifamily housing has great potential for profitability. Anything from apartment buildings, to student housing complexes, to townhomes would fall under this category. (You can check out this 16-unit short-term rental property on our website here.)
Due to the growth of e-commerce and logistics industries, industrial properties like warehouses, light manufacturing facilities, and distribution centers are in high demand. These properties may offer good potential for long-term leases and rental rate increases. (Click here for a view of a new multi-phase industrial park on our website.)
There are two important trends that make self-storage properties valuable: the rise of e-commerce and the trend towards smaller living spaces. These facilities offer relatively low maintenance costs and can generate steady rental income. (Check out this 79 unit self-storage property on our website here.)
Interested in all our other listings, check out our property search page, or click here for our investment offerings.
Lease vs. Sale
The decision between leasing and selling when it comes to commercial property ownership comes down to your financial goals, risk tolerance, and investment strategy.
Let’s break down the pros and cons of leasing and selling:
Leasing
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Pros |
Cons |
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Recurring revenue: Rent payments from tenants offer a steady stream and predictable stream of cash flow. |
Limited profit potential: Your profit is capped by rental income since you won’t benefit from appreciation in the property’s value. |
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Lower upfront costs: You don’t have to deal with costs associated with selling, like realtor and closing fees. |
Tenant dependence: Your income stream relies on good, timely-paying tenants. |
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Appreciation potential: Over time, rent prices may increase depending on the market. (Keep in mind you don’t directly own the appreciated value of the property.) |
Tenant issues: If issues arise, you may be responsible for resolving any tenant problems during the lease agreement. |
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Less management responsibility: Depending on the type of lease, the tenant may shoulder maintenance upkeep. |
Selling
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Pros |
Cons |
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Potential higher profit: If the market is strong you may get the full appreciated value of the real estate. |
Lose predictable income: You lose out on the predictable rent income from tenants when you sell. |
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Free up capital: Use freed up invested capital to fund other investment opportunities. |
Higher upfront costs: You’ll be liable for realtor fees, closing costs, and other expenses. |
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Less management stress: Once you sell, you’re no longer liable to deal with tenant issues. |
Up to the market: Current market conditions affect your success of selling and the price you ultimately get. |
When weighing the options for leasing or selling, consulting with a qualified commercial real estate professional can offer invaluable insight. They may provide expert advice on the current market landscape, analyze your specific property, and help you navigate the decision-making process to choose the path that best aligns with your financial goals.
Interested in us helping you navigate this complex process, reach out and we’ll connect you to a broker.