There have been a lot of questions about the state of the commercial real estate industry in the last two years. With more people working from home offices and retail storefronts closed to the public, the industry is in a period of transition.
Despite these obstacles, there’s good reason to remain optimistic about the future of commercial real estate. Let’s take a look at some of the challenges and opportunities in today’s industry.
First, some definitions
Commercial real estate refers to a property used exclusively for income generating purposes. An office space, storefront or multi-family rental are all examples of commercial real estate.
Usually, commercial leases are for longer periods of time than residential leases, and the larger the space, the longer the lease.
Investing in commercial real estate
Because there’s a limited amount of commercial land available in any city, the demand for property isn’t going away any time soon. This means investing in commercial property can lead to great returns. The longer leases on commercial properties also offer a more stable source of income than residential units. Plus, having tenants occupy your building for an extended period time ensures that your mortgage payments are covered—assuming you allocate the rental income appropriately.
Tip: You want to ensure that the commercial property you’ve invested in is well-maintained and kept up-to-date over the course of your investment. Not only will it keep your tenants happy, but it will help increase the sale value of the property.
Direct and indirect investing
When it comes to investing in commercial real estate, you have two options, both with their own unique rewards and challenges.
Direct investing is when investors own a physical property, and lease out the premises to others. This generally requires a lot of startup capital, due to the high prices of commercial property. A lot of strategizing is involved in direct investing, so if you’re considering it you should have a strong knowledge about commercial property and the real estate business.
Indirect investing is when you effectively own stock in a commercial property. For instance, you might own market securities such as exchange-trade funds or real estate investment trusts, or you might invest in banks or realtors who have an active role in commercial real estate ownership.
With every challenge comes opportunity
The pandemic has brought with it a number of challenges to our everyday lives. The commercial real estate industry has seen its own obstacles, and individuals and businesses have evolved as a result.
Michael Davidson is a commercial real estate generalist with Re/Max Realtron Group. In his twenty years of experience, he has seen the CRE market evolve with the times. During the last eighteen months, he observes “the sustainability word has come into play where business owners have had to sharpen their game.”
Michael Davidson notes “for the landlords, it was the challenge of dealing with trying to keep the tenants that they had.” It was critical that landlords “work with [tenants]… using the stimulus that was provided, the programs, to help lessen the burden of the tenants having to pay rent while they may not have been working.”
The hard details
The opportunity to make money from commercial real estate is substantial. Not only does the building itself appreciate in value, but you’re also making money off the units you lease within the building. At the same time, commercial properties require a lot of attention and careful management, as units need to be occupied and optimized.
Commercial real estate can generate some great profits for you, but not only does investing in commercial real estate require great amounts of startup capital and knowledge, there are additional risks and challenges associated with it.
Tip: If you’re considering investing in commercial property, and don’t have vast knowledge or experience in it, consider working with a management firm to help you with day-to-day operations.
There are also many legal requirements and restrictions when it comes to commercial real estate, from purchasing and taxes to maintenance and jurisdiction. All the legalese requires specific knowledge and precise attention to detail, lest you accidentally miss something that can lead to crippling complications.
Because of the specialized knowledge commercial real estate investment requires, it’s a good idea to do your research before jumping into the game. Take the time to speak with other experts in the field who can provide you with advice, and be sure you really know what you’re in for.
Commercial real estate can also see high turnover. While leases are generally longer, companies and business still close down all the time. The greater degree of turnover can lead to higher uncertainty, especially in the new work-from-home environment. Even if you have a commercial building in a highly desirable section of downtown, there’s still a chance that units could go unoccupied.
Did you know? While leases are generally longer-term, the pandemic affected them in a significant way. In February of 2021, the average lease length was 47 months, compared to terms of 70 months in February of 2020. Despite this, the terms are starting to rebound, now averaging 68 months.
Best use of space
Specific businesses have specific requirements for space. Some businesses might quickly outgrow their offices, and others could find that the space doesn’t fully work for their needs. This can add to the turnover problem, and necessitate more renovations and upkeep required to prepare a space for a new tenant. You want to invest in a space versatile enough to attract a wide array of potential clients, and adaptable enough to meet different business needs.
As an investor in commercial real estate, it’s critical to consider your tenants’ needs, and anticipate how they will interact with their space. Michael Davidson observes that because of the pandemic and the state of the commercial real estate industry, “people will need to really re-evaluate their business model a little more often than they did in the past.” He believes it is important for tenants to ask questions like “is the location really suitable for me? Is this a functional space for me? Would it be more effective for me to maybe spend a little bit more on my rent[…]to get a better location?”
Tip: Before investing, try to think like your tenants. Are you offering the best space for their needs? What makes your units unique and attractive to certain clients?
None of us have crystal balls, and it’s hard to tell what tomorrow will bring. How many of us could have anticipated the past year that we’ve had?
As businesses adapt to the changing marketplace, a new set of challenges and opportunities will present themselves. Michael Davidson observes “the next challenge is going to be for people to work together with the landlord and with their realtor to reconfigure a space with their budget… with a space that is functional for their staff who are going to be working hybrid.”
That said, there is reason to be optimistic for the future. “My indicators are that people want to return back,” he notes. “At this stage, now, we’re starting to see good signs,” he continues “[…] It’s amazing that Toronto was so resilient…. You haven’t seen a lot of mass closures.”
Be sure to consider what amount of risk you’re able to take on before you start investing in a commercial real estate venture. You don’t want to find yourself sitting on an unused property.
Do you have experience investing in commercial real estate? Let us know in the comments.
Note: This is intended to be used as general information only and does not constitute investment advice. Please conduct your own research before making any investment decisions.
James Battiston is a graduate of the Canadian Film Centre’s Prime Time Television Program, and holds an honours BA in Cinema Studies from the University Of Toronto. James has written for shows as varied as CBC’s Shoot The Messenger and The Border, to the National Geographic Program Mayday and Fuzzy Tales for TVO Kids.