Is Commercial Real Estate a Good Investment? (Pros & Cons)
As an investor, you should seek to secure your wealth against market volatility and inflation. Despite interest rates rising in the past three years, commercial real estate may still be an attractive investment option for you.
But navigating the complex commercial real estate market requires expertise. Here we examine the pros and cons of investing in commercial real estate so you can make an informed decision. We’ll provide an analysis of why we think commercial real estate may be a good investment and present a case for partnering with experienced private equity firms like Wellings Capital.
You’ll learn how our hands-on approach and extensive industry relationships are designed to access quality assets with a robust tenant pool. Whether you’re considering self-storage, industrial, retail, RV parks, or multifamily real estate, investments in commercial real estate can play an integral role in a diversified portfolio when pursued prudently.
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Is Commercial Real Estate a Good Investment? (The Pros)
Why invest in commercial real estate?
In many cases, commercial real estate has remained a stable hedge against inflation for investors. This hedge is largely derived from the many benefits associated with investing in this asset class.
Here are some of the benefits of commercial real estate investing that make it stand out among other asset classes:
1. Stable Cash Flow
Commercial real estate offers the potential for stable cash flow. Compared to the volatility of the stock market, commercial real estate investors may enjoy a more stable and predictable income. This is often true for assets with long-term leases, where rental rates are often fixed, providing steady income for years.
2. Tax Benefits
Commercial real estate investments may also provide attractive tax benefits. The depreciation deduction policy, for example, may allow you to deduct a portion of the property value each year, reducing your taxable income, depending on your tax bracket.
You may also be able to defer real estate taxes by using a 1031 exchange to roll over the proceeds from selling one property into a new investment. Many investors use a “swap-till-you-drop” 1031 strategy that allows them to avoid capital gains and depreciation recapture taxes during their lifetime.
3. Appreciation
Over time, commercial property values typically appreciate, which should build your equity in the investment. As rental rates increase and property values rise, your equity stake in the property should increase, translating into the potential for significant gains upon sale. While past performance doesn’t guarantee future success, commercial real estate has historically outpaced inflation.
For investors looking to build wealth over the long run, commercial property is an attractive choice with significant tax, income, and growth benefits. At Wellings Capital, our team endeavors to save you the stress of prospecting for profitable investments. With over 900 investors in six private equity funds, we can help you seek to achieve the benefits of investing in commercial property with fewer hassles, freeing up your time to do other things. Schedule a call with our team to learn more about our strategy.
Before we wrap up, you should know that investing in a commercial property equally has some downsides you should be prepared for. We’ll go over the main ones below.
The Cons of Commercial Real Estate
When investing in commercial real estate, you should be prepared for some drawbacks.
Here are the disadvantages of commercial property:
1. More Intensive Management
Owning commercial real estate requires far more management time and effort than a residential one. You have to handle tenant relations, ensure proper maintenance, negotiate lease renewals, and deal with other issues. If you don’t have experience managing commercial real estate, you’ll need to hire a property manager which adds to your costs.
2. Illiquidity
You may have pondered, “Should I buy commercial real estate for fast cash?”
Commercial real estate investments are often less liquid than residential property or securities. Depending on factors like location, property type, and market conditions, it can take months or even years to sell a commercial building.
If you need to sell quickly, you may have to accept a lower price, which defeats the goal of real estate investment. Hence, the relative illiquidity of commercial real estate needs to be considered, especially if you foresee needing access to your capital within a short timeframe.
We recommend investing in real estate only if you plan to hold it over the long term. While this may seem like a disadvantage, it’s truly an advantage—and has an undervalued power—for most people who want to build multi-generational wealth.
While commercial real estate can be an attractive investment, you must have realistic expectations about the potential downsides and risks involved. By understanding the higher management needs and relative illiquidity, you can make a better-informed decision about whether commercial property is right for your investment portfolio. Nonetheless, there are ways to navigate these downsides, as we’ll see below.
Tips for Mitigating the Disadvantages of Commercial Real Estate
To safeguard your real estate properties, you need to analyze the pros and cons of investment in real estate. Managing investments takes time, market knowledge, and dedication to remain profitable; that’s why many high-net-worth individuals embrace investing in real estate private equity funds (like Wellings Capital) or a REIT (real estate investment trust). These are professionals whose only job is profiting from the real estate market and you may be able to enjoy this wealth of experience without stress rather than employing a trial-and-error approach.
However, if you’re managing your portfolio yourself, you’ll want to consider the following to minimize risk:
Protect against costly repairs
Diversify your tenant base
Prepare for economic downturns
Stay on top of local market conditions
1. Protect against costly repairs
Schedule regular maintenance and upkeep to prevent expensive emergency repairs. Inspect HVAC, electrical, plumbing, and structural elements annually and budget for periodic replacements of high-cost equipment like chillers or boilers. Staying on top of repairs and renovations also makes your property more attractive to tenants, allowing you to keep vacancies low and charge premium rents.
2. Diversify your tenant base
Don’t put all your eggs in one basket. A single tenant occupying an entire building could vacate at the end of their lease term, leaving you with a sudden 100% vacancy. Seek out tenants from diverse industries, preferably on staggered lease terms. If one tenant leaves, you’ll still have rental income from the remaining occupants.
For more insights on diversification, you can explore our blog posts on retail real estate investment and industrial real estate investment. These examples highlight the importance and benefits of diversifying your tenant base.
3. Prepare for economic downturns
Recessions can impact commercial real estate if your tenants are subject to economic downturns, potentially reducing occupancy and rental rates. Understanding the pros and cons of investing in property is not enough; it’s equally important to build up cash reserves to protect your investment in case tenants default or vacancies rise.
Consider fixed interest rates over variable rates to lock in predictable payments. Diversify your portfolio across geographic areas and property types, too. Buying commercial real estate in sectors like healthcare, education, and logistics also tends to be recession-resistant.
4. Stay on top of local market conditions
Commercial real estate is intensely local. Stay up to date with job growth, business expansion and contraction, infrastructure projects, and competing properties in your area.
Look for signs that demand for your property type may weaken or strengthen in the coming years. Be ready to make strategic changes to your leasing, renovations, or pricing to adapt. A robust market knowledge helps you anticipate and respond to both risks and opportunities.
With prudent management and a long-term perspective, commercial property can be a good investment. Pay close attention to your property and tenants, prepare for economic changes, and keep a finger on the pulse of your local market. By mitigating risks and disadvantages, you can position your commercial real estate for stable returns over time.
But if you prefer a more hands-off approach to owning commercial property, consider our private equity firm. We focus on recession-resistant assets, which have helped many investors safeguard their wealth against inflation and taxes. Contact us now to learn more.
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Frequently Asked Questions
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Commercial property remains an appealing investment. It offers the potential for robust capital growth, a steady stream of income, and usually more security than the fluctuating stock market. It’s a tangible asset that can serve as a reliable cornerstone in a diversified investment portfolio.
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The profitability of a property often depends on two key factors: how inexpensively it can be acquired relative to its intrinsic value and how efficiently it is managed to unlock its potential income and value. Commercial properties with multiple tenants—such as multifamily complexes, industrial parks, mobile home parks, self-storage facilities, and mixed-use developments—often generate high returns on investment. This is largely due to their potential for consistent rental income.
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The average return on commercial property investments is often in the low- to mid-teens annually. It’s typically broken down into two categories: income from operations and equity growth from appreciation. Income typically varies from 4% to 10% annually, depending on various factors. Appreciation can often range from about 3% to 10% annually, depending on the level of leverage and many other factors.
While some investors focus on growth and seek returns just surpassing financing costs, others aim for a substantial income to support their lifestyles along the way. Investment objectives greatly influence what is considered a “good” return. And as always, it’s critical to assess the risk you’re taking to achieve a given return — smart investors are seeking the best “risk-adjusted returns,” not just the best returns.
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Yes, you can make money from commercial property through two primary ways: rental income from tenants and capital gains from the property’s value appreciation upon sale. When combined, these returns can make commercial real estate a lucrative investment. Since real estate is not closely correlated to public markets, investors can also gain safety through diversification.
Conclusion
Ultimately, commercial real estate may be a good investment if you take the time to understand the risks and rewards. Working with an experienced real estate private equity partner like Wellings Capital may provide access to prime properties and allows you to leverage their decades of expertise. Though not without pitfalls, commercial real estate continues to offer savvy investors strong cash flow, favorable tax treatment, portfolio diversification, and inflation hedging.
Don’t try to go it alone in this complex arena. Partnering with the right firm can help you capitalize on commercial real estate opportunities while mitigating the challenges. With careful analysis and trusted guidance, commercial real estate investment can play a valuable role in protecting and growing your wealth in 2024 and beyond.
If you have any questions, please contact us or use this link to schedule a call with us.
DISCLAIMER: This article is for educational purposes only and is not to be relied upon as the basis for entering into any transaction or advisory relationship or making any investment decision. Wellings Capital Management, LLC is an Investment Adviser registered with the SEC. All investments pose risk, including the possible loss of all principal invested. Past performance is no guarantee of future results. There is no guarantee that any projected results will be achieved. Investors should consider the investment objectives, risks, charges, and expenses of any Welling Capital investment vehicle before investing. For a Private Placement Memorandum (“PPM”) with this and other information, please call 800-844-2188 or email invest@wellingscapital.com. Please read the PPM carefully before investing.
The information contained in this article is for information purposes, does not constitute a recommendation, and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be in violation of any local laws. All investing involves the risk of loss, including a loss of principal. We do not provide tax, accounting, or legal advice, and all investors are advised to consult with their tax, accounting, or legal advisers before investing. Information and any opinions contained in this article have been obtained from sources that we consider reliable, but we do not represent that such information and opinions are accurate or complete and thus should not be relied upon as such.