6 Reasons to Invest in Commercial Real Estate

For many investors, the thought of buying a commercial property is enough to make them curl up in a ball, suck their thumb, and cry out for mummy. Okay, that’s a slight exaggeration, but you get the point.

If you’ve been to any of Steve’s live events recently, you’ve heard him teach a basic long-term strategy of transitioning over time from growth to income. After building up your kitty through residential property investment, Steve suggests cashing out and buying debt-free commercial real estate.

The principle is simple: You’ll achieve greater capital growth through residential property, while earning greater income through commercial property.

Here are the top six reasons why you should consider commercial real estate as an important part of your long-term income producing strategy:

1. It’s Not Personal, Sonny. It’s Strictly Business

In this famous clip from the cinema classic, The Godfather, Michael Corleone tells us the primary difference between residential and commercial real estate.

One of the primary growth drivers in the residential market is the emotion that accompanies nearly every transaction. People tend to fall in love with a home. People build their dream homes. Even investors often have an emotional attachment to their first property investment.

But, how many times have you heard someone say, “Today I saw the most beautiful office building, and I knew immediately that was the place I had to spend my days,”? It generally doesn’t happen like this.

Commercial real estate is valued differently. While location and economic factors are primary drivers of demand, at the end of the day, the rent a tenant is willing to pay really comes down to useable square meters.

This business nature of the transaction can simplify the relationship between landlord and tenant, making management of the property much more hassle-free. When your goal is passive income, hassle-free property becomes a major bonus.

2. Commercial Real Estate Generally Offers Higher Yields

In most areas, as growth in the value of residential properties has outpaced increases in the price of rents, the gap between residential and commercial yields has widened significantly.

While gross rental returns for residential investors in capital cities are currently in the 3 to 4% range, commercial investors have continued to receive higher returns.

In Session 12 of the Property Apprenticeship course, Steve offers the following guidelines for the level of yield you can expect in the commercial real estate market:

• Retail: 4.5% to 8% yield
• Office: 6.5% to 8% yield
• Industrial: 7.5% to 8.5% yield

After conducting a simple five-minute online search, I was able to find returns in Melbourne CBD of 9% plus.

3. Commercial Property Tenants Pay The Outgoings

When your residential tenant needs their bathroom tap tightened or has grass growing out of their gutters, who do they call? And what about council rates? Have you ever had a tenant offer to pay those?

With commercial lease agreements, the tenant is usually expected to pick up the tab for all outgoings, such as rates, insurance, land tax, management fees, repairs and maintenance.

This can have a profound impact on your net return. The fewer upkeep costs you have, the more of your rental income that you get to keep. This is why Steve says, “A dollar of commercial rent is worth more than a dollar of residential rent.”

4. It’s Up To The Tenant To Make Improvements To The Fit Out

When you own a commercial property, there’s no need to worry about that future renovation. The tenant is the one who usually pays the expenses of installing shop fittings and fixtures. It’s also usually the tenant who is expected to pay to remove the fit-out when the lease comes to an end.

5. Automatic Rent Increases Are Built Into The Lease Agreement

How did your residential tenant feel the last time you raised their rent? Maybe you should send them that link to The Godfather clip.

A solution would be to buy commercial real estate where the lease agreement will often include fixed rental increases. Sometimes the expectation is a flat percentage increase of perhaps 3 to 5% per year, or it could be pegged to the consumer price index.

Either way, this makes commercial property a great hedge against low interest rates and the easy monetary policies of central bankers.

6. Commercial Real Estate Leases Are Usually Longer And Have Renewal Options

I once heard from an investor that he had a little old lady living in one of his units who had been there for over 20 years. Of course, he hadn’t raised her rent very much, but at least he didn’t have any vacancies.

This, of course, is not the norm. More frequent turnover of tenants means more weeks without rent, which means less money in your pocket.

The typical commercial lease is often a two to three-year agreement, with five-year leases also quite common. Some lease agreements may even be signed for as long as 20 years.

It’s also standard practice for agreements to include renewal options. For instance, when you see a “3 x 3 x 3” lease advertised, that means the tenant has signed a three year lease, and has the right to renew that lease again for another three years, and again for another three years after that. In other words, this could end up being a nine-year tenant.

What Are The Risks?

As with any investment, higher returns come with higher perceived risks. In order to manage any risk, you must first be clear on exactly what could go wrong.

Here are the common threats that scare most people off from commercial property:

• Vacancy Risk: People will always need a place to live, but people may not always need a place to do business. This means residential vacancies could last weeks, while commercial vacancies could last for months or years.

• Economic Risk: Commercial tenants are engaged in business, and the longevity of business is dependent on the health of the overall economy. If the economy nosedives, so could your income. This is why some investors see retail space as less desirable than office or industrial complexes.

• Scale Of Investment: Commercial properties tend to be more expensive than homes. This presents a potential barrier of entry into the market. But this can also mean that commercial properties can have more expensive problems.

If any of these concerns are enough to send you running in the opposite direction, don’t stress. Commercial real estate should be part of your long-term plan. Sure, you’ll need a higher level of investing skills to overcome these threats, but time is on your side. While you’re building your kitty through residential investing, continue to educate yourself and become a more competent, well-rounded investor.

By Jason Staggers

Jason was a personal mentor working with Steve McKnight's Property Apprentices. He helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom. Jason now lives in Perth, WA where he leads Neuma Church.