What Is a Good ROI on Commercial Real Estate?
Commercial real estate (CRE) is an appealing option for many investors or would-be investors who see the potential for consistent returns, passive income, and growth. Understanding how to calculate ROI—including accounting for the myriad variables involved—can help your decision-making process. Up-to-date, accurate data is a vital piece of the CRE puzzle.
Many current and would-be commercial real estate investors cite the appeal of factors like consistent returns, passive income, and growth potential. The relatively stable nature of the market makes it an appealing investment type, as it’s not going to wildly fluctuate based on market cycles.
If you’re thinking about investing in commercial real estate (CRE) as a means to diversify your portfolio with dynamic new opportunities, you’ll want to understand the basics of this investment type’s potential return on investment (ROI). In this blog, we’re going to look at what factors impact the ROI you can expect, highlighting the importance of commercial real estate data.
What Are the Benefits of Investing in Commercial Property?
It’s essential to consider the pros and cons of buying commercial property for investment before making any concrete decisions. A myriad of potential benefits from investing in commercial real estate can include:
- The potential for high income
- Tax benefits
- Reduced competition (vs. residential real estate)
- Diverse investment opportunities
- Minimal turnover
What’s the Income Potential for Commercial Real Estate?
With an average yield on commercial property between 6-12%, it represents a more lucrative opportunity than, say, single-family homes (which yield more like 1-4%). Some of the factors that impact this exact figure include the property’s location and condition, as well as overarching matters like the local, state, and national economies.
How Do You Calculate ROI for Commercial Property?
In short, ROI measures how much an investor profits from their commercial real estate investment. It’s typically expressed as a percentage. For cash transactions, the calculation is relatively straightforward:
- Calculate the net profit or gain (subtracting expenses from revenue)
- Divide that figure by the original investment cost
Other factors may play a role, depending on the nature of the purchase. For example, if there’s a mortgage involved, one has to consider the down payment and mortgage payments in the calculation. Beyond that, any repairs or maintenance costs or other expenses also reduce the final ROI figure.
This is the most straightforward method for basic ROI calculations. There are several other ways to crunch the numbers based on different circumstances (e.g., Out-of-Pocket ROI, Cap Rate, Cash-on-Cash Return, Gross Rent Multiplier).
What Is a Good ROI for Commercial Real Estate Investments?
As you can imagine, there isn’t a single, definitive answer to this question. This is partially due to the diverse property types that fall under the commercial real estate umbrella, properties with their own financial implications, including, for example:
- Hotels and casinos
- Industrial warehouses
- Office buildings
- Retail stores
- Storage spaces
Your own risk tolerance as an investor also plays a significant role in what you might consider “good” ROI. It probably won’t come as a surprise to learn that the higher level of risk you can accept, the higher the potential reward (or ROI).
One widely-accepted method for gauging whether an ROI figure is “good” is to compare it with the S&P 500 Index’s average annual return. The idea is that any ROI that exceeds this figure is considered a positive. Over the past 20 years, the S&P 500’s average return has been around 10%, meaning a good ROI on commercial property is roughly 10% or above. Again, this is just a baseline, as there are many additional factors to consider (as discussed above).
How to Know If a Commercial Property Is a Good Investment
Market conditions may be outside of your control as an investor (or would-be investor), but that doesn’t mean you have to just go with your gut or trust brokers. The more you understand about the commercial real estate market—including how properties are valued and their near- and long-term future outlook—you can make better-informed decisions and know what kind of ROI to expect.
The truth is, calculating ROI can be simple, but it can also be incredibly complex. It depends on several property, location, and investment type variables, as well as the amount of risk you’re willing to take for the chance at a greater reward. It’s never a bad idea to enlist the services of an expert to help you assess the big picture—without missing any of the little details.
That’s where Canyon Data comes into play.
Precise, More Actionable Insights: That’s Canyon Data
We track 150 data points—three times as many as our competitors. We partner with local experts to provide CRE data that is up-to-date, comprehensive, and accurate. Our proprietary data collection process brings together everything you need to make better investment decisions: due diligence, market comps, and more.
We don’t just provide robust, high-quality data—we supplement the raw data with visualization tools, to highlight actionable data. Ready to learn more? Head to our website to learn all about what we do!