Buying a commercial property takes time. You need to know how the type of property you’re interested in actually performs to ensure long-term success.
You’re about to spend a few million as a first-time solo investor. You don’t want to make a choice you’ll be regretting after a large, ill-informed investment. So, before signing any offer to purchase, you need to know a few things about commercial property investment.
You already know commercial property is lucrative, but which is a better for you based on your available capital, your risk threshold and income and cash flow requirements – an office block or factory?
Related: The 3 things your tenants really want in their office space
“With a low growth rate, the uptake of office space is muted at best, and may even decline,” says Rodney Luntz, head of Commercial Broking Gauteng. Consider this when making your decision between investing in a factory or office space.
1. Questions to ask yourself
The first step in purchasing commercial real estate is knowing yourself, your situation, and what you're looking for.
What kind of property are you looking for?
Industrial properties include distribution, manufacturing or warehouse facilities, while offices are classified according to grade and location. Industrial tenants have limited office requirements and require highly customised space for heavy industrial use if they are large manufacturers.
What's your financial situation – can you make a down payment?
A larger deposit is required as 30% to 50% of the property’s value is unencumbered – the lower capital growth potential makes it harder to cover the interest paid on the loan.
How is the area around the property doing? Any major upcoming changes?
Do your homework now, to avoid learning a terrible lesson later. Visiting the properties on your shortlist is vital, because not only is location key, but you’ll experience first-hand the condition of the building and allowed uses.
2. Solutions to consider
If you’re used to DIY, you’d better be licensed to handle the maintenance issues at a commercial property, advises legal firm Nolo. As a real estate novice, you may not be prepared to handle maintenance issues yourself and will need help with emergencies and repairs.
This is where property management companies come in handy. Although they can charge between 5% and 10% of rent revenues for their services, including lease administration, they’re a great help in properly caring for the property.
Related: Low growth in office rental market
3. The pros and cons of commercial property investment
The best reason to invest in commercial over residential rentals is the earning potential. Commercial properties generally have an annual return of between 6% and 12%, depending on the area.
However, before you make money, you’re going to spend quite a bit. “Acquiring a commercial property typically requires more capital up front than acquiring a residential rental in the same area, so it’s often more difficult to get your foot in the door,” says Matt Larson, president of Cricket Realty Advisors.
Here are some more positives of commercial property investment:
- Businesses usually go home at night, so except for the odd emergency calls at night for break-ins or fire alarms, expect to only be working during business hours, just like your tenants.
- Lease terms are also more flexible with a commercial tenant as fewer consumer protection laws govern commercial leases. “Unlike the dozens of state laws, such as security deposit limits and termination rules, that cover residential real estate,” Larson adds.
And some challenges you’ll face:
- Once you’ve acquired a commercial property, you can expect some large capital expenditures to follow. A leaky roof is a bigger problem in an office or factory space than an apartment or other residential space. More tenants means more facilities to maintain.
- Since land appreciates, but buildings depreciate, potential for capital gain is lower. The building usually takes up most of the value on commercial properties and in addition is generally harder to sell as there are fewer buyers.
Commercial property is lucrative and a good choice for your first big real estate investment. Choosing between factory or office space depends on your financial capacity, the kind of lease you’re after and your tenant of choice.