The main difference between selling commercial real estate and residential real estate is the type and purpose of the property. This impacts the differences in selling styles.
Residential properties include single-family homes, apartments and townhouses. The owner of the property can live in the property or can rent it out space to enjoy rental income. There is typically an emotional element involved in residential real estate since it involves renting to individuals or families as their primary place of residence.
Commercial real estate refers to properties that are used for office, retail, industrial, and special purposes. There are also commercial properties used for residential purposes known as multi-family properties. The typical tenant of commercial real estate, other than multi-family, is a business or a corporation resulting in less of an emotional element.
However, there are numerous differences between selling commercial real estate and residential real estate. The following comparisons provide a better idea of these differences.
1. Time to Sell
Recently, with the dirge in inventory for residential real estate, homes are selling within days of being listed, unlike selling commercial real estate which can take months to find the right investor. There has also been a surge of residential property owners selling their homes to home buying companies such as Element Homebuyers and similar companies that offer fast home sale and immediate cash, are commission-free and eliminate the need to upgrade the home before listing.
2. Returns-On-Investment (ROIs)
The return on investment is what helps investors determine a property’s profitability. With that said, what’s the average ROI in the US real estate market? The S&P 500 Index can answer this.
According to the Index in 2019 before the pandemic has hit the world, The US has an average return on investment of 8.6%. Of course, it depends on the type of rental property. For instance, commercial real estate’s average return is 9.5%. On the other hand, residential rental properties have an average ROI of 10.6%.
Based on the data above, investing in residential real estate properties can be more lucrative than buying and leasing commercial properties. However, it’s essential to note that those figures don’t apply to all properties. That’s because vacancy rate, property management costs, and location are factors that also influence ROI.
Investors trying to compare residential and commercial properties should also look at other metrics, such as cap rate and cash on cash return.
3. Commercial Tenants Have More Money
Recently, retailers have faced increasing competition from e-commerce stores. Online stores offer products at a more affordable price and in a more convenient manner for consumers. Think about Walmart and Amazon. It’s no wonder why the retail sector hasn’t been performing at its best worldwide. Since many retail stores have shut down, the prices of commercial rentals have dropped drastically. In addition, due to the pandemic, finding qualified tenants for a commercial space can take five to six months nowadays.
However, what’s good about commercial spaces is that despite the higher vacancy rate these days, the typical tenants are businesses and corporations. When dealing with companies and large corporations, they would tend to have more financial leeway to afford higher or commercial rates of the lease. They also tend to be better tenants of the property because they maintain the property and respect its rules.
4. Triple Net Leases
The third difference is that when selling commercial real estate to potential investors is value of triple net leases that many commercial leases include. Under a triple net lease, the tenant directly handles and pays for all property expenses. These include real estate taxes, building insurance, and maintenance expenses. These payments are on top of paying for the rental fees. In these situations, the property owner’s only concern would be mortgages payments on the property, if there are any.
While triple net leases favor the landlord, some tenants (companies or businesses) may prefer them because they’ll have more control over maintaining the building. Not to mention that triple net leases also bring more transparency than other lease types.
5. Longer Term Lease
Commercial property leases tend to be longer term as compared to residential property leasing. Home rentals typically have a term between six to 12 months. By contrast, it’s a common practice to lease commercial properties between five to 10 years.
This is an advantage and benefit that you can point out when selling commercial properties to real estate investors. Long-term leases would mean they don’t have frequent turnover costs. They don’t have to make those repainting and repair works too frequently each time a tenant leaves and a new one comes in. It also means lower vacancy rates, which means that there wouldn’t be too many months that their property isn’t earning money for them.
An added advantage and benefit of longer-term leases is that it goes into the cash flow performance of the property. Having long-term leases means there’s money coming in more regularly from month to month.
Take note that the fair market value of commercial properties doesn’t depend on the next-door neighbor or adjacent property pricing followed in residential properties. The value of commercial real estate is determined by the amount of money that it generates. This is discussed next.
6. How Property Values Increase
The fifth difference that you can point out when selling commercial real estate is that the value of commercial properties isn’t primarily influenced by comparable neighboring properties. The fair market value of commercial real estate is primarily determined by its revenue generation.
The cash flow earnings of commercial property have a direct impact and tend to increase the fair market value of the property. If a commercial property is leased out to a high income-generating business, then the property will increase in value much faster than a home.
By contrast, the fair market value of a home is largely dependent on the selling price of the neighboring home that was most recently sold in the vicinity. This gives the commercial real estate investor a more active role in increasing the value of the property by choosing a tenant with higher cash flow and returns, rather than just waiting for how much the neighbor’s property would be sold.
Selling Money Makers
In selling commercial real estate, you’re really selling to the prospective investor is a future flow of income, hopefully a potential money maker. More likely than not, it’s also the primary reason why they are looking into buying such property. So, paint a clear picture about income flow in the past and how much more money it can make in the future. In short, show them the money.
If you are interested in either buying or selling commercial real estate, we can help. Contact us to find out more.