What Type of Commercial Real Estate Is the Best Investment?
In this blog we’ll explain how to know if a commercial property is a good investment. The answer is to use accurate commercial real estate data to analyze the market and individual property you are interested in to make the best decision at the right time.
Commercial real estate (CRE) as a market is a huge industry within the US, estimated to generate over $1 trillion in 2022 and expected to grow 4% this year alone (according to IBISWorld). With such a large and potentially profitable industry, it is no surprise that individuals and organizations of all sizes are interested in getting involved in commercial real estate as an investment.
In this blog we’ll explain how to know if a commercial property is a good investment. The answer is to use accurate commercial real estate data to analyze the market and individual property you are interested in to make the best decision at the right time. Canyon Data is a partner you can trust to provide all the data you need. Let’s look into the broader question of “What type of commercial property is most profitable” to get a better understanding of the big picture of CRE.
What Are the Types of Commercial Real Estate?
Before we can get into the specifics about types of CRE, we need to know what the basic types are. There are several different ways to divide types, but these are the basics:
- Office space
- Industrial use – warehouses, factories
- Multi-family rental
- Hotels and Motels
- Land – agricultural, vacant land available for development
- Miscellaneous – self-storage, parking lots, stadiums, zoo and other hard to categorize use cases
What Is a Good ROI on Commercial Real Estate?
There are a lot of factors that go into what you can expect the return-on-investment to be for a CRE property. But as a general range, an annual return of between 6% and 12% of the purchase price is typical, depending on the economy, location of the property, and other factors.
A commonly asked and related question is “is it better to invest in commercial or residential property?” When looking at ROI, the answer is pretty straightforward. With an ordinary single-family residential property, the yearly ROI is between 1% and 4%, significantly less than the ROI on commercial properties.
Another thing to keep in mind with ROI in CRE is the amount of management associated with different properties. If you are looking for passive income commercial real estate, you will need to pay a property manager to deal with the day-to-day running of the commercial property. Larger properties with higher rental income potential may actually generate a higher ROI because the cost of a property manager is a smaller percentage of the overall rent. If you choose some level of active management of your CRE property, smaller properties where you are able to manage the day-to-day running of operations without needing to pay an outside manager may increase your ROI.
What Commercial Property Type Has the Most Risk?
Now that we’ve looked at the different types of CRE, and the pros of CRE investment over residential in terms of ROI, let’s explore some of the risks of investing in different types of commercial properties. First, let’s consider some risks inherent in all CRE to some extent, then look at how these risks may affect specific types of properties more than others.
General CRE Risks
- Macroeconomic: Changes in the overall economy affect commercial property value and cash flow.
- Liquidity: Money invested in CRE is no longer a liquid asset.
- Default: Tenants of CRE properties may default on rent payments or go out of business.
- Inflation: The rate of inflation can be predicted and included in the pricing of commercial units, but if inflation increases faster than predicted, rents will need to be increased to maintain ROI.
- Management: CRE properties must be managed effectively to be profitable. This must be done by the owner, or by a hired property manager.
- Location: Communities and cities are organisms that change over time. CRE property value can change dramatically based on changes around their location outside of their control.
Specific Risks by Property
Because each type of CRE is so varied, there isn’t one specific type that is higher or lower risk in every situation. There are some general rules that can be used to determine risk in a given situation that are worth considering, though.
- Purchase Price: The higher the cost of a CRE property, generally the more risk is involved. Larger buildings with more tenants, or large spaces with high rents increase the effects of inflation, management costs, risk of tenants defaulting, and tie up a larger amount of liquid assets.
- Socioeconomics of the Area: CRE properties in lower socioeconomic areas are generally higher risk, because finding and retaining tenants may be more difficult.
- Repair and History of Property: CRE properties that have been well maintained and have a history of stable tenants are lower risk than properties that need a lot of updating or have struggled to retain tenants in the past.
Is Now a Good Time to Invest in Commercial Property?
The short answer is yes. Although all financial investments involve some level of risk, all signs are pointing towards the CRE market going up. The COVID-19 pandemic had adversely affected the market in 2020 and the beginning of 2021, but “the recovery that started in the second half of 2021 is continuing into the first quarter of 2022” according to the National Association of Realtors. This trend of net positive absorption in 2022 is across all CRE sectors – retail, office, industrial and multifamily. It is projected that rents and property values will continue to rise for CRE investments.
Data Driven Decisions Make All The Difference in CRE
There are obviously many factors that go into deciding what CRE investment is best for you. The one thing that is true for all of them, though, is that accurate data about an individual property and the area around it will help you make better decisions. Whether you are a broker, developer, investor, appraiser, lender, property manager or involved in CRE in some other role, the complete and verified information Canyon Data has to offer helps you get the most from your investment.
If you are ready to see the Canyon Data Difference, let’s chat today!