I recently switched from investing in small multifamily properties to focusing on non-residential commercial property investing, and I have found it to be a great decision. In fact, I wish I had made the switch sooner. There are several reasons why you may want to consider making the switch to non-residential commercial properties, or at least diversifying your portfolio in this direction.
There is less competition in the non-residential commercial real estate acquisition process. As someone who has been investing in multifamily properties for 10 years, I can attest that establishing relationships and credibility with brokers can be a challenge. In contrast, when I started searching for retail centers on Crexi, I was pleasantly surprised to receive callbacks from two marketing brokers just because I clicked on their properties.
With non-residential commercial properties, there are simply fewer buyers to compete with, so brokers need to chase prospective buyers. While you may not find a gift-wrapped smoking deal, you can find good deals just by searching for them on-market. By investing a little more time and having an understanding of complex value-add options, you can find deals that will return 20% cash-on-cash with additional value-add options available.
The concept of value-add is the same across all real estate asset classes. In multifamily, value-add business plans involve improving NOI by either increasing income or decreasing expenses through capital expenditure. In commercial deals, changing one tenant can have a profound effect on the value of a building. For example, a mentor of mine purchased a $5M strip mall at an 8% cap rate. One of the larger tenants was paying almost 50% below market rent. They found another tenant who was willing to pay market rent, and once the space was rented, the property's NOI was increased by over $100K monthly. At an 8% cap, this resulted in a $1.25M increase in value just by replacing one tenant with no capital expenditure. The new tenant improved the space they were renting to suit their business needs, which allowed rent throughout the strip center to be increased upon renewal with no additional investment from ownership.
Non-residential commercial tenants need to make investments and improvements to the commercial properties they lease in order to operate their businesses, which in turn improves the value of the property. For example, an industrial building tenant that does materials testing invested in an upgraded HVAC and venting system in order to run their tests. Additionally, their equipment and chemical storage was certified for the current leased space. These kinds of investments help to retain tenants since they would have a significant upfront cost to leaving. If the tenant were to leave, they would have to leave the mechanical systems behind, which could be marketed to a new tenant at a higher cost.
Non-residential commercial properties offer more flexibility than most multifamily properties. While multifamily properties have a singular use of housing people, vacant space in non-residential commercial properties can usually be divided in different ways depending on the needs of the tenant. This provides an opportunity to be creative and help tenants become more successful.
Non-residential commercial properties offer great investment opportunities and returns, making them an excellent alternative to the competitive multifamily market. It's a good idea to invest some time in learning about different commercial real estate sectors that can balance out your portfolio.
About the Author:
Vijay Prabhakaran is a commercial real estate investor who has invested in small multifamily properties in Chicago over the past decade, which allowed him to replace his take-home pay and shift to non-residential commercial properties. As a Best Ever blog contributor, Vijay aims to share his experience achieving financial independence and his decision to focus on multi-tenant retail and industrial spaces in the Midwest.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.