Investing in Commercial Real Estate Investing in commercial real estate can be lucrative and serve as a hedge against the volatility of the stock market. Investors can make money through property appreciation when they sell, but most returns come from tenant rents.

Direct Investment Investors can use direct investments where they become landlords through the ownership of the physical property. People best suited for direct investment in commercial real estate are those who either have a considerable amount of knowledge about the industry or who can employ firms who do. Commercial properties are a high-risk, high-reward real estate investment. Such an investor is likely to be a high-net-worth individual since CRE investing requires a considerable amount of capital.

The ideal property is in an area with low CRE supply and high demand which will give favorable rental rates. The strength of the area’s local economy also affects the value of the CRE purchase.

Indirect Investment Alternatively, investors may invest in the commercial market indirectly through the ownership of various market securities such as Real Estate Investment Trusts (REITs), exchange-traded funds, or by investing in companies that cater to the commercial real estate market, such as banks and realtors.

Advantages of Commercial Real Estate One of the biggest advantages of commercial real estate is attractive leasing rates. In areas where the amount of new construction is either limited by land or law, commercial real estate can have impressive returns and considerable monthly cash flows. Industrial buildings generally rent at a lower rate, though they also have lower overhead costs compared to an office tower.
Commercial real estate also benefits from comparably longer lease contracts with tenants than residential real estate. This long lease length gives the commercial real estate holder a considerable amount of cash flow stability, as long as long-term tenants occupy the building.

In addition to offering a stable, rich source of income, commercial real estate offers the potential for capital appreciation, as long as the property is well-maintained and kept up to date. And, like all real estate, it often moves in the opposite direction to the stock market, making it an effective diversification option to equities in a portfolio.

PROS

• Hedge against stock market
• High-yielding source of income
• Stable cash flows from long-term tenants
• Capital appreciation potential

CONS

• More capital required to directly invest
• Greater regulation
• Higher renovation costs
• Illiquid asset

Disadvantages of Commercial Real Estate Rules and regulations are the primary deterrents for most people wanting to invest in commercial real estate directly. The taxes, mechanics of purchasing, and maintenance responsibilities for commercial properties are buried in layers of legalese. These requirements shift according to state, county, industry, size, zoning, and many other designations. Most investors in commercial real estate either have specialized knowledge or a payroll of people who do.
Another hurdle is the increased risk brought with tenant turnover, especially relevant in an economy where unexpected retail closures leave properties vacant with little advance notice. 

With residences, the facilities requirements of one tenant usually mirror those of previous or future tenants. However, with a commercial property, each tenant may have very different needs that require costly refurbishing. The building owner then has to adapt the space to accommodate each tenant’s specialized trade. A commercial property with a low vacancy but high tenant turnover may still lose money due to the cost of renovations for incoming tenants.

For those looking to invest directly, buying a commercial property is a much more costly proposition than a residential property. Also, while real estate, in general, is among the more illiquid of asset classes, transactions for commercial buildings tend to move especially slowly.

Real World Example of CRE Forecast The U.S. commercial property market took a hit during the 2008-2009 recession, but it has experienced annual gains since 2010. These gains have helped recover nearly all recession-era losses.

The “2019 U.S. Real Estate Market Outlook,” an annual report issued by CBRE, believes: Although it is late in the economic cycle, the outlook remains very good for all four major commercial real estate asset types.

There will be minimal appreciation in values, but income returns should remain healthy.However, other indicators suggest the commercial property market has peaked in the post-recession growth cycle. According to California real estate firm, Ten-X Growth, commercial property pricing ended 2018 up just 1% from 2017.

A Ten-X report noted that the 2018 final total for commercial properties confirms their view of the late economic cycle pricing. The firm’s research found that vacancies are rising, rent growth is slowing, and market interest rates are on the rise

As reported by Forbes, the retail sector, in particular, has proved a pain point in the broader commercial property market, as widespread store closures intensified in 2017 and continued into 2018. For example, popular mall REIT Westfield Corporation saw their stock price shed about 30% between mid-2016 and late 2017 before reversing some losses through January 2018. Unibail-Rodamco SE acquired Westfield for US$15.8 billion, creating Unibail-Rodamco-Westfield (URW).

Most firms, however, maintain that the property market remains healthy overall. J.P. Morgan, in its “2019 Commerical Real Estate Outlook,” largely echoed CBRE’s view stating that 2018 was the ninth year of increases in commercial property rents and valuations. Morgan predicts this pace will slow but continue and do not see a downturn until after 2019.