Risks of Commercial Investing: Weighing the Pros and Cons

Location, location, location. We’ve all heard the importance of choosing the right geography when it comes to investing in properties. But what are the other risks and how can you navigate them to feel confident as an investor?

What are Commercial Investments?

Commercial investments are investments in a for-profit business venture with the goal being strong returns. Two of the most common examples are commercial real estate properties, such as office buildings or hotels, and franchises.

Commercial Investment Risk Factors

Risk may include liquidity risk, financial interest risk, administrative risk, etc.

• Real Estate Volatility As the economy fluctuates, so does commercial real estate. However, rates also fluctuate with the economy: both high and low. This can be a rewarding advantage at times, and it can also pose a disadvantage. If the economy starts to decrease, this can be a disadvantage to commercial real estate. It is likely that tenants occupying these commercial buildings will struggle making their monthly payments.
  
  
• Administrative Tenants play a major role in commercial investing. Finding loyal, trustworthy tenants that pay as agreed, are mindful of the real estate they are leasing, and aware of economic conditions is just as crucial as the investing itself.
  • One way to mitigate this is hiring a management company to manage the commercial real estate. Although this is the most logical business tactic, it’s important to note this could be expensive and risky if the right steps are not taken to hire a competent management company.
    
    
• Digital Takeover It’s no secret that the future is upon us. Technologies such as AI, drone deliveries, and e-commerce have reshaped the consumer landscape and brick-and-mortar business has taken a major hit.
  • As with any investment, it’s imperative to do proper research to ensure your venture will be a profitable one. Gain a competitive advantage by setting your business apart from the rest in a meaningful and positive way.
    
    
• Construction and Distribution No matter how much planning and vetting goes into a commercial project, some things are just outside of investor control. As we saw in the wake of Covid, distribution of materials such as steel and lumber can be halted for weeks and prices can skyrocket to record highs.
  • Be mindful of economic conditions when deciding to invest. Furthermore, mitigate this risk by finding reputable, trustworthy commercial development and construction firms and sticking with them throughout the process.

Many of these risks can be minimized by the investor being knowledgeable regarding the economic state and current financial offers given. Rates and terms are critical components of investing because the annual debt service will determine the income prevailing annually. Maximizing profits by putting a larger down payment towards the loan will allow for increased profits annually due to a decreased payment. This will also decrease the risk for future endeavors and sales of the property since less will be owed against the real estate.

Pros of Commercial Investing

Commercial investing can have a multitude of advantages to it. However, some may be too shy to explore them due to the aforementioned potential risks involved.

• Strong Economy In contrast to poor economic conditions, if the economy starts to increase, this can be an advantage to commercial real estate. Tenants are likely to become more stable with their payments as rates start to decrease and cash flow increases.

• Cash Flow Commercial investments have the potential to provide strong and steady cash flows for investors. They can sometimes even offer tax advantages.

• Diversification It’s no secret that all the pros recommend diversifying your investment portfolio. Commercial investments can be a powerful addition to more traditional investments, such as stocks and bonds.

How to Get Started as a Commercial Investor

• Determine Areas of Interest: There are different types of commercial real estate, but basically four main categories - industrial, office, retail, and multi-family. Which ones to target are completely up to you, but you should identify the key characteristics of properties that interest you to determine the best fit.

You can also research economic forecasts for the performance of different types of commercial real estate. The pandemic has reshaped the real estate industry as a whole, so keep that in mind as you’re exploring options.

• Be Mindful of Economic Conditions: It’s no secret that the economy is the greatest determiner of investment performance. In light of rising rates and turbulent economic conditions, it’s important to be intentional. In general, long-term contractual leases are on the safer side. If a property is under a lease with a longer term, there's less worry for investors in regards to economic volatility.
  
  
• Commit: Becoming a commercial investor is no small thing – make sure that you and your finances can support sticking with it for the long haul.
  
  
• Find a Reliable Lender: This is the key to getting started as a commercial investor. When making such a large financial commitment, it’s imperative you partner with people you can trust. Seek out experienced commercial lenders, especially those familiar with the area you’re hoping to purchase property in.

Although there’s risk and reward that come with commercial investing, the key takeaway is that it’s most beneficial to become knowledgeable about investing in order to take advantage of positive opportunities.

Having knowledge of the risks involved and knowing how to weigh them could be the beginning of a successful business. Commercial investments are time consuming with more capital up front but have one of the best long-term benefits.

To learn more about commercial lending and investments, you can contact me or stop by one of our convenient locations.

OMB and its affiliates do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decision. Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value. This material is not intended as a recommendation, offer or solicitation for the purchase or sale of any security or investment strategy.