Managing Risk in Commercial Real Estate Investments
Being a commercial real estate investor can be extremely lucrative since commercial property leases tend to yield more for the property owner than residential leases of similarly-sized properties. In addition, commercial real estate leases also have longer durations with tenants staying in the property for much longer than the typical residential lease. Like residential real estate, commercial properties also tend to appreciate over time, especially when well maintained. In many parts of the United States, especially in urban city centers, there are restrictions on new building construction which can further drive up the prices of existing real estate as demand often outstrips supply. This potential for regulation-driven appreciation is another advantage to commercial property investment that is less common in the residential market.
Although more income stability, asset appreciation and higher lease prices per square foot make commercial real estate more attractive for some investors, there are some unique risks involved that create barriers to entry and that can potentially affect return on investment.
These risks can be mitigated by forming the right relationships with professionals who specialize in commercial real estate. Successful commercial real estate investors have the right advisors and partners in place to help manage the risks associated with investing in commercial properties.
Risks Associated with Commercial Real Estate
The market for commercial properties presents challenges that can be solved by partnering with the right professionals.
The first challenge facing investors is that the commercial real estate market is heavily regulated. The cost and barriers to entry presented by these rules and regulations form a deterrent that makes direct investment in commercial real estate difficult for many individuals. Other inhibiting factors in the commercial real estate market include:
- Taxes, which are usually higher than those found in residential real estate
- Purchasing procedures, which are usually more involve more paperwork and cost than those required of residential properties
- Higher maintenance responsibilities and costs than residential properties
- Legalese can be a factor in commercial property investment. Different political subdivisions (districts, municipalities, counties, states and federal) have different codes, statutes and laws that affect local commercial real estate investment. These regulations form a complex and layered matrix of challenges that requires the help of an experienced local lawyer.
- Tenant demands are often higher and more costly in commercial real estate leases than they are in the residential equivalent. Tenants from different industries may require different refurbishment and outfitting needs. One example is a restaurant moving into a space formerly occupied by a clothing retailer. Depending on the lease negotiation, a large portion of the renovation may be covered by the property owner rather than the lessee.
- Tenant turnover due to bankruptcy and downsizing is a real threat in commercial real estate since businesses “move or die” at a much higher rate than the families and individuals who occupy residential properties. High turnover can result in unexpected vacancies which eat away at a property’s profit margins.
- Illiquidity is another factor in commercial real estate. While residential properties are relatively illiquid when compared to capital market investments such as stocks and bonds, commercial properties may be especially illiquid. This is due to the typically longer sales process and increased transaction costs associated with commercial properties.
The Importance of Experienced Advisors
The hazards and risks associated with commercial property investment are manageable by hiring a team of experienced real estate advisors. While the costs of working with professionals may seem expensive, the real costs associated with “going it alone” may be more prohibitive in the long run. Here is a shortlist of the advisors recommended to help investors achieve success in the commercial real estate space:
Real Estate Attorney
An experienced real estate attorney can help investor’s to navigate the maze of codes, regulations, statutes and laws that govern the sale and management of commercial properties. Real estate attorneys can typically also provide title and escrow services as well as review sales agreements and draft lease agreements. By using an attorney licensed to practice law in the state in which the commercial real estate investment is located, investors can ensure that their best interests are always taken into consideration as they proceed with property transactions and leases.
Real estate attorneys can typically also provide title and escrow services as well as review sales agreements and draft lease agreements.
Commercial Real Estate Agent
Another advisor that can deliver a great deal of value to an investor’s bottom line is a good commercial real estate agent. Investors would do well to engage a state-licensed real estate broker with extensive experience in the purchase, sale and rental of commercial properties in the specific area in which the investment is being made. Local experience and expertise is important because, as mentioned earlier, local codes and regulations can present unique challenges to investors. An experienced local commercial real estate agent will most likely have seen the specific challenges before and have solutions for handling them. Good real estate agents will also work in tandem with property investors’ lawyers to ensure that all documents are drafted and reviewed by a legal expert before being presented to the other side of the transaction.
Insurance Agent or Broker
Protecting assets is very important in real estate in general. This is especially so in the realm of commercial real estate where property values and assets held in the property can often cost millions, tens of millions or even hundreds of millions of dollars. Investors can work with a trusted P&C insurance agent to make sure that the right levels of insurance coverage are in place to protect their investment in the case of damage or destruction.
South Florida Law
Investing in real property involves many moving parts. However, the process of managing a commercial real estate portfolio can be particularly complex. Be sure not to “go it alone”. South Florida Law, PLLC is your legal partner, prepared to protect your best interest. We provide a variety of resources and solutions to equip buyers, sellers and agents with the protections necessary to close deals and manage properties with success. South Florida Law also assists in the title insurance and title search process, handling contract matters, reviewing agreements and representing our clients in commercial real estate transaction closings. Are you selling or buying commercial property in the State of Florida? If so, call us on (954) 900-8885 or use our contact form for a free consultation.