4 Reasons Why Sophisticated Investors Prefer Commercial Real Estate
There is no denying that there are many types of real estate investments which can be alluring, and even profitable. We can’t go a day without hearing about high house prices and the bidding wars over them in the media. Yet, despite the trend in house flipping TV shows, and low interest rate home loans, the best capitalized and experienced institutional and savvy individual investors continue to trend towards commercial property. Here are five of the drivers why investors continue to choose commercial real estate:
Regulation & Liability
Regional banks, credit unions, funds, private lenders and family offices all understand that commercial real estate is far less risky in terms of regulation and liability, as opposed to dealing with residential homes and condos, which can be a mine field. Regardless of whether the property is leased or owner occupied, there are many legal risks which can lead to big financial losses, through no fault of the investor. Commercial investments may be regulated too, but without such exposure to frivolous legal issues.
Consistency in Asset Values
Residential real estate values can fluctuate drastically over time. While investors can generate great profits on the upswing, the losses can be even greater on the downturn. These turns are inevitable and although residential real estate is often less volatile than the stock market, the illiquidity of a slow-moving property and pose a problem for investors.
Commercial properties are valued on their income potential and performance, and are not as susceptible to major fluctuations based on neighbors defaulting on mortgage debt, or selling out cheaply. This results in more stability and liquidity.
Value Add Potential
You can make money by fixing and flipping houses, or tearing down a few homes and erecting a condo building. However, there is typically a cap on when you can make these improvements, and how high you can go. In commercial real estate there are consistent opportunities to add value. This can be accomplished in a multitude of ways including: upgrading the tenant pool and rents, through lowering expenses and improving NOI, increasing traffic and sales to a retail property, or adding additional leasable square feet. The returns on improvements to commercial property tend to be higher, and can work during any phase of the market.
Efficiency & ROI
Commercial properties tend to be worth more than individual homes or condo units. For example; a single family home may sell for $1M, and a local shopping plaza or office building may sell for $20M+. For sophisticated investors with capital, this means being able to be more efficient in the investment process. There is less time, energy, and wasted dollars burned in the acquisition process. They can take down one asset, versus 20 or more, and get the same result. This translates into higher net returns. Individual investors can also benefit from these efficiencies of scale by partnering with others on commercial projects.
While some Canadian housing markets continue to appear to be red hot, sophisticated investors keep leaning towards commercial real estate for a variety of important reasons, including those above.