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Commercial real estate has long been a stable investment for people who want to diversify their real estate investments beyond residential rental properties. But before you dive in head first, you should consider the pros and cons that come with this asset class.

What is Commercial Real Estate?

If you’re new to the world of real estate investing, you might find all the terminology a little confusing. And while you might be intimated to say anything, you’d really like to strip things back to the basics so that you can get some solid footing before taking action. So let’s start by exploring the what of commercial real estate.

As investor Kasey Tross puts it, “Commercial real estate is a property that has the potential to generate profit through capital gain or rental income. Commercial property can be anything from an office building to a residential duplex, or even a restaurant or warehouse. If you can make money from leasing it out or holding it and reselling it, it’s a commercial property.”

While the average investor is focused on residential real estate, commercial properties provide a unique opportunity to grow and diversify a cash-flowing portfolio.

The Advantages of Investing in Commercial Real Estate

Commercial real estate is an advantageous investment class for a variety of reasons. Here are several of the top benefits:

  • Steady cash flow. You can typically expect a higher average annual return rate for a commercial property than for residential real estate. And in most cases, commercial properties are sold with tenants already in place. This allows you to generate positive cash flow from day one without having to worry about the immediate challenge of finding a new tenant.
  • Specific lease terms. There are tons of rules and regulations regarding residential real estate leases. And while commercial real estate still has certain requirements, fewer rules are generally in place regarding leases. This gives you the ability to totally control lease terms and craft something that satisfies your own needs and goals.
  • Fewer tenant issues. Residential tenants can be finicky and unpredictable. Chasing down late rent payments is one of the biggest downsides to owning a residential rental property. You also have to worry about whether or not people are going to respect your property and keep it in good shape. With commercial real estate, there are fewer tenant issues. All leases are usually drafted automatically on the same day of the month. Plus, businesses prioritize their lease payments before almost any other expense.
  • Long-term leases. With commercial properties, it’s not unheard of for a tenant to sign a two-, three-, or even five-year lease. Talk about some serious security! This allows you to make accurate long-term cash flow projections.

The Disadvantages and Risks of Investing in Commercial Real Estate

While there are many benefits associated with commercial real estate, we would be remiss not to mention some possible risks and disadvantages. These include:

  • Potential legislation. According to those in the industry, the potential for more restrictive legislation is something to keep an eye on. As Crown Commercial Property Management explains, “Legislative risk, sometimes referred to as regulatory risk, is fairly unlikely yet certainly possible. This risk refers to the potential for alterations in laws and regulations such as zoning. Such changes to laws and regulations are local as opposed to regional or nationwide.”
  • Inflation. As inflation continues to increase, it’s possible that many businesses will be forced out of the lease market and will instead look for ways to go virtual (thereby eliminating their need for commercial space). This could hurt the market and lead to a surplus of vacant properties, which would drive down lease rates and property values.
  • Poor liquidity. With residential real estate, you can pretty much decide when you want to sell and have the house listed, under contract, and closed within a couple of months. With commercial properties, there are fewer buyers and more logistical challenges to work through. Selling the property and cash out can take a year or longer. This lack of liquidity is definitely a negative.

Grow Your Investment Portfolio

As you build your real estate investment portfolio, it’s smart to diversify. This includes diversifying with multiple properties in multiple locations and in multiple asset classes. From residential to commercial, there are plenty of opportunities for you to get your feet wet!

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