Investing in commercial real estate can be very lucrative in terms of profits. However, it might be difficult for inexperienced investors to know what kind of commercial property to purchase. Investors might choose to put their money into everything from flats to office buildings to industrial sites and anything in between. Real estate investment prospects can be more thoroughly evaluated if you have a firm grasp of the benefits and drawbacks of various commercial property types. As such, the purpose of this essay is to contrast two distinct forms of real estate investments, specifically, those in multifamily housing and those in office space.
In particular, we’ll delve into the following areas:
- Investment in Office Space: Pros and Cons
- The Benefits and Risks of Buying Multifamily Properties
- Conclusion
Investment in Office Space: Pros and Cons
An Overview of Office Space
Commercial properties designed for white-collar enterprises are classified as office space. In terms of its primary purpose, an office is still primarily an office regardless of its physical location. As a result, instead of sub-categorizing this property category by function, investors break down office properties by 1) age, 2) condition, and 3) location. Investors categorize office buildings into three broad categories: Class A (the newest, best quality buildings), Class B (the middle ground), and Class C (the lowest quality buildings) (oldest, in need of repairs, less desirable location).
In terms of geography, the following are the most common types of office buildings:
- Central business district (CBD) properties
- Commercially zoned houses
- Suburban office buildings
Investing in Office Space: Pros
The difficulties involved in relocating an office are often underestimated. Relocating your firm will disrupt because of the necessity to transfer employees, furniture, and other equipment physically. The effect is that commercial tenants often commit to longer lease terms than their residential counterparts. Office leases can range from five to ten years, depending on the circumstances. When looking at it from an investor’s standpoint, the stability of the cash flow and low turnover requirements are two major benefits of these longer lease agreements.
Office buildings also commonly house several companies (though single-tenant offices exist). The other tenants in the building can frequently cushion the blow to the landlord’s cash flow if a single tenant vacates the building, making this commercial real estate advantageous.
Investing in Office Space: Cons
Office space is mostly used for conducting business. Hence its success tends to mirror that of the economy as a whole. Investments in office buildings and their tenancy rates fare well when the economy is doing well. This feature, however, also reflects one of the major drawbacks of purchasing commercial real estate. Office building performance, particularly in Class B and Class C, is notoriously bad amid recessions and pandemics.
The challenge of tenant placement is another drawback of commercial real estate investment. In everyday life, it’s not uncommon for people to uproot and relocate. Companies are less likely to relocate than people. Finding a new tenant for an empty office can take significantly more time than renting an apartment, often resulting in longer vacancies. This is why, when underwriting a mortgage on an office property, many financial institutions require a ten percent vacancy loss assumption (as opposed to the 5 percent vacancy loss standard with multifamily properties).
Finally, many investors have difficulty with offices because of a lack of familiarity. Since most of us have been tenants at some point in our lives, we have an innate familiarity with lease agreements and the demands of renters. However, many investors have never signed a commercial lease for office space, so they lack first-hand experience with the requirements of office tenants and the commercial leasing procedure. Investors should be aware of the possible negative posed by this unfamiliarity, even if they may solve it with the help of a commercial real estate broker during the lease process.
The Benefits and Risks of Buying Multifamily Properties
A Multifamily Overview
Property having numerous dwelling units is considered multifamily commercial real estate. For a definition, multifamily dwellings include units with two to four units. In terms of financing, however, these properties are typically considered “residential” by most banks.
On the other hand, apartment complexes with five or more units are considered commercial property. Consequently, commercial lending is generally used by investors to provide debt finance for such properties. The following is not an exhaustive list, but it does cover some of the most prevalent kinds of multifamily properties:
- Garden-style apartments
- Mid-rise apartments
- High-rise apartments
- Student housing/dorms
- Senior and assisted-living
Benefits of Multifamily Investing
Having a sense of community is a huge plus for multifamily dwellings. Apartment living is a common experience, even for those who have never bought into a complex. Therefore, there is already an established level of comfort between the landlord and tenant. In other words, a landlord is better positioned to assist their renters because of a greater familiarity with those tenants’ requirements and overall profile.
Apartment buildings also have a significant cash-flow advantage over other types of commercial real estate. In contrast to industrial real estate, where the loss of even a single tenant can cause a catastrophic drop in cash flow, multifamily real estate is more tolerant of tenant turnover. The income from the remaining apartments can make up for the loss of a few tenants in a residential building. In a 50-unit complex, for instance, two empty units probably won’t prohibit you from meeting your mortgage obligations.
Risks of Multifamily Investing
There is a direct correlation between this benefit of apartment buildings and their major drawback, which is their high turnover. Most apartment contracts are for a year or less, so residents come and go regularly. These turns incur a direct labor and maintenance expense and the costs associated with vacancy. The landlord (or management business) is responsible for cleaning and painting the flat when a tenant moves out and advertising the unit to potential new tenants. These turnover charges can constitute a sizable proportion of overall operating costs in a property.
Conclusion on Multifamily vs. Office Space Investing
Both of these variations on real estate have their advantages and disadvantages, as shown. Those needing greater stability in their investments may do well to consider purchasing office property. However, multifamily investing may be preferable for investors who wish to minimize vacant periods with tenants whose demands they already know. Remember that your choices among the investment above vehicles are not exclusive. Some investors choose to have both multifamily and office exposure in their portfolios to reap the benefits of a diversified real estate portfolio.
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