Commercial Real Estate

A Look at the Pros & Cons of Investing in Commercial Real Estate

Expertise: Business Management, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate Deal Analysis & Advice, Commercial Real Estate, Personal Development, Real Estate News & Commentary
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When I first got into commercial real estate investing, I was actually working as a real estate agent. My boss at the time wanted out of one of his deals, a 6-unit building consisting of 3 efficiencies and 3 two-bedroom apartments outside of Philadelphia, so I took the plunge and bought it.

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(Note: Anything over 4 units is considered commercial.)

Before I bought my first commercial property, I had about 10 years of experience investing in single family residential (SFR) properties, and investing in commercial real estate myself seemed like the logical next step.

I learned quite a bit from this first deal, as well as the other commercial deals that followed, but I’m glad I had some experience to draw from and that I took the time to educate myself about what I was getting into.

Have you considered commercial property? If so, the first thing I would recommend for those new to this type of investing is to meet with at least one commercial lender and one commercial-focused real estate agent. Before you start looking for deals, it may help to figure out what the banks want to lend on and to find agents who specialize in these properties.

Also, before you jump in, consider some of the advantages and challenges of commercial real estate investing. It is completely different from investing in SFR. Here’s how.

3 Advantages of Commercial Real Estate

1. More Flexible Financing

When it comes to commercial real estate, financing can be much more flexible.

You can buy these very large, valuable properties with none of your own money. For example, when the company I raised money for purchased the mobile home park, it was mostly with private money, and the seller held back a mortgage as well.

Related: 4 Ways Technology is Shaking Up Commercial Real Estate (& Why Multifamily Will Pull Ahead)

For commercial deals, you can also utilize auxiliary financing (up to 100 percent financing, with first or second mortgages), while traditional residential financing tends to frown upon 100 percent financing. Also, valuations are based on rent roll instead of comparable properties nearby.

That said, you may be able to utilize more leverage on a bigger amount, while only having a single mortgage on a commercial property with 50 units, as opposed to 50 mortgages on 50 different SFR properties.

2. Use of Economies of Scale

With more units in one place, you can often develop more favorable contracts with your contractors or outside vendors and negotiate lower costs for improvements and maintenance. You just need the lure of more volume to get them to negotiate.

The most efficient apartment complexes are over 100 units because that enables them to afford on-site help. With an on-site team, you can turn over apartments much more quickly. Although you may still need to bring in some outside contractors, the need would be lessened. I noticed this when I was a painting contractor, as our customers were apartment complexes of all different sizes, and the largest ones needed us less because they had their own staff.

3. More Passive

Of course, if you have on-site maintenance, it’s more passive for the owner as well.

If it’s an office building, you only have a tenant during business hours, and there may be limited maintenance calls during off hours.

If you have a "net-net-net" (or "triple-net") lease in place, which is common with commercial, the tenant is usually responsible for any ongoing property expenses, including taxes, insurance, and maintenance, in addition to paying the rent and utilities.

Although investing in commercial real estate can be more passive than residential, your yield may be lower, especially if the property is more expensive and has a lower cap rate.

2 Challenges of Commercial Real Estate

And here are some disadvantages/challenges to consider. 

1. Increased Competition

When it comes to commercial properties, most buyers are looking for opportunity or room for improvement. They often want to increase the value of the commercial property, as this could allow them to refinance with cheaper, traditional financing and buy out their investors (i.e. private or hard money lenders).

This is similar to what I did with the 6-unit building I bought from my boss. It had a high turnover rate on the 3 efficiencies, so I converted the 6-unit building to a triplex (three 4-bedroom and 2-bath units) and paid off the expensive commercial loan with residential financing.

As a buyer, it may be challenging to find existing commercial properties where the numbers make sense, and you would likely have a lot of competition for this type of property.

Maybe the seller is asking too much for the place or there’s too much deferred maintenance. Or maybe there’s not enough room to raise rents or to lower vacancies.

Related: Applying for a Commercial Mortgage? Here’s What You’ll Need

2. The Risk of Poor Management

Let’s say you did find a great commercial property. Will your property management team be able to handle it? Based on whether tenants’ needs are regularly met by management, will the tenants feel comfortable paying a higher rent amount?

If you have a poor manager or an underperforming property management company, this can cause some challenges. I'd say the big questions to ask when hiring a property manager or property management company are the following:

  • How efficient are they?
  • How much experience do they have?
  • Are they compliant?

It’s important that you monitor your property management company to make sure they are managing the property well and that they have the bandwidth to manage all of your units. For example, are evictions filed on time? Is maintenance getting done?

Property management companies often work better with responsive landlords, so if you’re on top of things, your management company may follow suit.

Other potential disadvantages may be that that turnover is often higher in apartments than it is in houses, and the cost of insurance is higher.


My Take on Commercial Real Estate

Considering some of the pros and cons of commercial real estate, I still think that it’s a valuable and profitable investment vehicle for many people. Personally, at this stage in my life, I’d rather remain more passive and I enjoy working with larger numbers. So, I would probably lean more towards investing in commercial than residential.

That said, there are many different ways that one could enter the commercial space. For example, you could own the land, the buildings, the businesses, or any combination of the three.

So, will investing in commercial real estate be your next step, or is it something you look forward to doing later, or will you stick to SFR? Why or why not?

Leave your thoughts below!

Since 2007, Dave Van Horn has served as president and CEO of PPR Note Co., a $150MM+ company managing funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 30 years of residential and commercial real estate experience as a licensed Realtor, real estate investor, and private lender. In addition to his investments and role at PPR, Dave’s biggest passion is teaching others how to share, build, and preserve wealth. He authored Real Estate Note Investing, an introduction to the note investing business, helping investors enter the “other side” of real estate.
    Christopher Smith Investor from brentwood, california
    Replied almost 4 years ago
    Interesting Article I’ve been contemplating for some time now making a jump from SFR’s to Commercial. I’ve been stymied by a few things: 1) The tax bite and transnational costs of disposing of my SFR’s (a bad thing) which are vastly appreciated (a good thing). Not sure how I should go about selling / disposing of them. 1031 is an option, but its a bit awkward and the additional transnational costs can be high. 2) The primary market where I have my SFRs (and where I live) is absolutely swamped with foreign cash inflows, and those investors are not generally too concerned with making a profit more just a place to park their money outside the long arm of their local governments. As a result, prices have been bid sky high and being a novice at the game to begin with I don’t see any realistic way I could make these “over priced” properties viable. 3) I have access to another secondary SFR market in the Midwest where I have put out the word that I am looking for commercial as well as SFR’s, but as with everything else, if you can’t be there that makes it more of a challenge to be successful in generating leads. 4) I’d frankly be happy at this point to give up some underlying price appreciation potential (which is fairly strong in my primary SFR market), for a moderately higher cash flow yield from a commercial property. Any thoughts?
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 4 years ago
    Thanks Christopher! As for your questions, outside of the 1031 exchange here are my thoughts: 1.) Well, who says you have to get rid of these SFR properties to get into commercial? Most of the commercial investing I have done is with none of my own money (unless I’m just putting skin in the game as a Class B member or capital contribution). I’ve raised private equity from other investors, pooling together money to buy commercial real estate – which is pretty common among most serious commercial real estate investors. If you’re not looking to raise money, you could just borrow out of your SFR properties and use that to invest in commercial as well. 2.) I think this goes into number 3 a bit, but commercial investing isn’t about staying local. In fact, most commercial investors I know (including myself) invest all over the country, usually in up and coming areas. And as a counterpoint: Why not make these foreign investors equity partners in your commercial real estate fund? 3.) I agree but I also think it comes down to having the right connections in the area that act as boots on the ground. These relationships don’t happen overnight but I would put the word out in local REIA’s in those areas or try to find interested parties here on BP. 4.) I don’t know if you need to give anything up. With commercial, it’s not as much about cash flow (which is always important) as it is about cap rate and increasing the property’s value based on net operating income. That’s just my take. I hope this info helps. Do let me know if you have any other questions. Best, Dave
    John Thedford Real Estate Broker from Naples, FL
    Replied almost 4 years ago
    Definitely my next serious move. Some of my friends have huge incomes from NNN commercial properties. They are making a lot of money, have tremendous freedom, and cash to do as they please. SFR have treated me well and given me a lot of freedom but nothing compared to my friends that invest in NNN commercial.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 4 years ago
    I agree, John! SFR’s just aren’t passive enough. Thanks for reading. Dave
    Kris Falcher from Tampa, Florida
    Replied almost 4 years ago
    I don’t think that investing in commercial is appropriate for newbies at this point in the business cycle. Competition is fierce, even after the massive run up in prices over the past few years. Instead, buy a few block houses in good school districts. And STAY AWAY from duplexes and quads in low income areas.
    Jake Moran Rental Property Investor from Falls Church, VA
    Replied almost 4 years ago
    Kris, what makes you so against multifamily residential in low income areas if I am a newbie? I was actually just looking at exactly that in Richmond VA. The cash flow looks amazing on paper, but is it not worth the headaches/risks?
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 4 years ago
    I’m with you on this one Jake. I think multi-units in low income areas can be a great entry way into the business. But I also agree with Kris on the commercial side in the sense that it’s usually tougher to enter that space unless you have a background in finance and raising private capital. Brian Adams (a contributor here on BP) was someone with little commercial experience that went into the space, I would suggest any newbies interested in commercial to reach out to him here on the site. Best, Dave
    Tyler Meredith
    Replied almost 4 years ago
    I like that you mention commercial real estate as being a helpful investment vehicle for a lot of people. It makes sense that since there are so many types of commercial real estate, investing in it can be a worthwhile and unique experience. I\’ll have just to remember that money isn\’t necessarily the most expensive part of commercial real estate investment, rather, the time and effort it takes to make that investment profitable. Thanks for the post!
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 4 years ago
    Thanks for the kind words Tyler! And that’s a great reason why I think teams are so valuable with commercial! Best, Dave
    Mark Lucido Investor from The Colony, Texas
    Replied almost 4 years ago
    Thank you Dave! I can’t understand why more people aren’t investing in commercial properties but that lessens the competition for me! I’m a newbie investor who still works full time in IT for a very prominant Fortune 100 company. I also have a 6 year old and am working on completing my MBA so I require something very passive yet I want to learn the in and outs of Property Managment. Because of my time constraints, I elected to enter REI via a C-Class commercial property in an area that is in the middle of regentrification. It’s been one of the best experiences of my life despite a few inherited tenants that fell behind. After writing off those losses I did replace those tenants with more suitable ones and I expect this year to be much better. I’ve bought a second property now (retail duplex) which has proven even better with 2 national tenants that pay via EFT on the 1st of every month. Commercial will be in my future for some time.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 4 years ago
    Thanks Mark! Your story is an inspiring ones to any other newbies out there! Best of luck in all your future commercial endeavors. – Dave
    Replied almost 4 years ago
    Commercial real estate definitely gives you more leverage over your debt and more scalability, but with that comes more required diligence and planning. As you mentioned, having a good property management company with great visibility into what they’re doing is crucial.
    Rich Hupper Broker / Investor from Tewksbury, Massachusetts
    Replied almost 4 years ago
    Thank you for this post. Does anyone know what the terms of commercial notes usually look like compared to residential? Would it ever be possible to use a commercial loan on a 1 to 4 family residence? Thank you
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 4 years ago
    Hi Rich, It would be possible to use a commercial loan/commercial blanket on 1 to 4 family SFRs in a portfolio, if it’s large enough (I’ve usually seen these start at a minimum of about half a million). The terms are stricter with commercial loans in some ways, and in some ways they’re more lenient. Most of the commercial loans require that you personally sign, unless it’s pretty substantial loan, (think over 70 units), in which case the loan is more based on the property rather than the borrower. And if it’s a large enough property, you may even qualify for a non-recourse loan. Commercial loans are stricter in terms of LTV (Loan to Value), so you’re not getting anything like a 3% down FHA mortgage. But it’s worth noting that, although they may required a larger percentage down, the flipside of that is they’ll allow you to bring in auxiliary financing – like owner financing or private equity. The loans also have shorter amortizations (to take risk off the table for the lender) which vary anywhere from 15 to 25 years, whereas residential is usually 30. Lastly, commercial loans often recast every 5 to 7 years (or sometimes 10 years at most). The bank does this to protect them against interest rate risk, but the downside for the borrower is if their financial situation changes, they may not be approved for said loan if they’re required to personally sign. Hope this info helps! And thanks for reading! Best, Dave
    Rich Hupper Broker / Investor from Tewksbury, Massachusetts
    Replied almost 4 years ago
    Thank you Dave That is great information
    Parthiv Dangodara Investor from Fort Lauderdale, Florida
    Replied almost 4 years ago
    Great post. I’m getting ready to make the jump into commercial. Any thoughts on what is considered a good cap rate these day? I can’t seem to find much better than 5-6% in B or C areas.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 3 years ago
    Thanks! The demand for commercial pieces is up, so that could be why you’re seeing 5-6%. Also it could be the market you’re buying in. My friend who is a very successful Commercial Investor says it’s not as much about the initial cap rate as much as it’s about the opportunity to improve the commercial space. There’s a book called “The Perfect Investment” by Paul Moore that you may want to check out. It does a good job discussing cap rate and improvement, and the market and sub-market analysis as well. Best, Dave
    Matt Szura Real Estate Agent from Red Bank, NJ
    Replied over 3 years ago
    Hey Dave, I am currently in the process of buying my first commercial property, a mobile home park. The financing is my biggest hurdle right now, can you explain auxiliary financing a bit more or at least point me in the right direction? Thank you, Matt
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 3 years ago
    Hi Matt, Most mobile home parks are sold with owner financing, not much institutional financing for MPH’s these days to my knowledge. Even back when I was doing Mobile Home parks there wasn’t much out there. Auxiliary financing means the bank will allow a seller 2nd mortgage (or a mortgage from another party). In the article, when I mentioned it, I really meant auxiliary financing for commercial properties that aren’t MHP’s. Best, Dave
    Ken C. from Winter Garden, Florida
    Replied over 3 years ago
    Hello Dave, I recently attended a seminar titled “The how-to’s of wholesaling small apartment buildings” hosted by my local REIA. The presentation sounded very interesting, considering the far much greater profit potential compared to single family wholesaling. What are your thoughts on getting involved in wholesaling small apartments as a novice? I currently have an 401K that I want to rollover into a SDIRA as means to fund any future RE investments. Also, after looking over some of the topics on your website THE PPR NOTE COMPANY pertaining to performing and non-performing RE notes the information really sparked my interest, to not only, want to know more about getting involved in the note business, but, actually purchasing notes. I look forward to your reply, Thank you kindly.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 3 years ago
    Apologies for the late reply. I’ve never had any experience with wholesaling small apartment buildings, but I imagine it would be more difficult than wholesaling SFR since they usually require proof of funds, and commercial is more controlled directly by brokers. I suppose the idea of optioning commercial property can make sense, although it’s a bit of a gamble. As for notes, you can definitely find more info on where you’ll find our Intro to Note Investing E-book as well as our free bi-monthly Note Investor Q&A Calls. Hope this helps. Best, Dave
    Phuong Dinh from Lincoln, Nebraska
    Replied over 3 years ago
    Hi how can i find our get connected with commercial-focused real estate agent in my area? Thanks
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 3 years ago
    Hi Phuong, Anywhere businesses meet, you’ll usually find a commercial focused RE Agent. So that could mean anywhere from the golf course or country club to business associations and business clubs. Best, Dave
    Kylie Dotts
    Replied over 3 years ago
    It would make sense that certain leases would make the tenant responsible for any ongoing expenses involved with your commercial real estate. This would be much easier than trying to accommodate the customer by making any changes to the building and having to go through a middle man. It would be far easier to simply allow them to make any changes necessary through their own means.
    Kevin Keithley Developer from Menlo Park, CA
    Replied over 3 years ago
    Great post! This is a must read and a must know by everyone planning to invest in commercial real estate.