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What is Commercial Real Estate?
 
Commercial real estate is a broad category of assets that are bought to make a profit through rental income, price appreciation, or both. The space in a commercial building is typically leased to other firms, who utilize it to run their enterprises. There are three main categories of properties for people interested in investing in commercial real estate, each of which has its own risks and advantages.
 
Offices: Office space is created to meet the business’s specific requirements. Moving a business can be challenging and expensive, so office investors benefit from long-term leases and low tenant turnover. These same leases, however, can also include pricey tenant renovations and sporadic rent increases.
 
Industrial: Industrial properties include stand-alone warehouses, logistics centers, or “flex” spaces and are identified by their “industrial” purposes. Investors in the industrial sector profit from stable cash flow, less operational risk, and low capital expenditure needs. Due to their substantial physical footprints, industrial spaces may have high upfront costs and are vulnerable to economic upheavals.
 
Retail: Strip malls, shopping malls, and independent bank offices are classic examples of retail property. Long-term leasing activity and strong visibility are advantageous to retail property owners. However, it can be challenging and expensive to re-lease them without extensive improvements, which can influence tenants’ financial stability.
 
Benefits of Investing in Commercial Real Estate
 
Commercial real estate (CRE) has a proven track record of providing favorable returns over time as an asset class, which, combined with other advantages, makes it a desirable investment choice. There are numerous important advantages for people who decide to invest in commercial real estate assets, including:
 
Diversification: Investing in commercial real estate can add a new level of diversification to an investment portfolio, which is beneficial during a recession. Changes in the price of commercial property typically have little in common with those of more conventional asset classes like stocks and bonds.
 
“Forced” Appreciation: Commercial properties are valued by the Net Operating Income (NOI) - a property’s income less its operating expenses. This differs from the NOI of residential properties based on sales comparables. An owner can directly affect this calculation and the total worth of their property by increasing or cutting costs.
 
Dispersion of Vacancy Risk: Most commercial buildings have more than one tenant, so if one tenant decides not to renew a lease, it won’t have as much of an impact as it would in a residential property. Investors are less dependent on any one unit for income when they invest in commercial properties since they may spread their vacancy risk over several units.
 
Income: One of the main advantages of owning commercial real estate is the income stream created by the regular rent payments made by tenants to the property owner. Revenue might generate a healthy return if the property is bought at a price that reflects its quality and value for money.
 
Lease Escalations: Escalation provisions, which require rent increases at predetermined intervals throughout the lease period, are frequently included in commercial leases. Contractually required lease escalations mean that the money generated by the property will increase with time, assuming that expenses remain primarily unchanged.
 
Tax Benefits: A commercial real estate investment offers two main tax advantages. Real estate owners are permitted to “expense” a portion of the property’s value every year to account for it because real estate’s physical condition deteriorates with time. Therefore, depreciation is used to lower the tax obligation for the asset.
 
Inflation Protection: Commercial real estate can be used as an effective inflation hedge because it is a physical, “tangible” asset. Developers delay building projects if their net operating income increases quickly enough to counteract an increase in expenses (caused by inflation). Rents tend to increase in a market with limited supply, which raises property values and net operating incomes.
 
Availability of Debt: Lastly, because commercial properties generate income, lenders for commercial real estate are comfortable taking on the risk of lending to them. Debt is frequently available for retail real estate investors, regardless of the property type, at generally advantageous terms.
 
Commercial Property Risks
 
Commercial real estate investing can have several advantages, but there are some risks involved. Potential investors in commercial real estate should take into account the following risks and difficulties before investing money in a deal:
 
Cost: Commercial properties are generally more expensive than residential ones, requiring a higher initial outlay, but it is still within reach for some investors. There are several ways for investors to pool their funds to buy a commercial asset, and it is possible to do so without overspending.
 
Market Risk: In response to broader macroeconomic conditions, real estate markets are dynamic and constantly changing. Commercial premises are mostly shielded from these changes while tenants are under a lease. Market risk, however, refers to the chance that a tenant may elect not to renew a lease when it is up for renewal or that the current market lease rate at that time is lower than what the tenant was paying during the first lease period. These factors make it crucial to comprehend the particulars of each market before investing.
 
Just like other types of investments, commercial real estate investment also comes with risks, which can be managed. The overall risk exposure can be decreased through experience, knowledge, and active risk mitigation techniques.
 
 
Written By
Mayeesha Azam