What are the Disadvantages of Owning Commercial Property?

If you own an apartment building, a warehouse or a retail space, what you have is a commercial property. Unlike a residential real estate, a commercial property doesn’t serve as a home for people. Instead, it is used for business, as a workspace, or for other income-generating activities.

Commercial properties can be categorized into four classes: multifamily rental, office space, retail, and industrial properties. They can include a wide range of real estate properties, such as office buildings, apartment buildings, warehouses, hotels and resorts, restaurants, strip malls, and healthcare facilities.  

A well-run commercial property could benefit greatly from having the following (we’ll discuss in greater detail later):

• Property Management company
• Commercial Insurance
• Public Adjuster to manage insurance claims
• Regular maintenance and repair services to ensure the property remains in top condition
• Security services to safeguard the property and its tenants
• An energy management system to optimize energy use and reduce costs

However, to be considered a commercial property, the owner must have bought it for the sole purpose of earning a return through price appreciation or capital gain, or rental income, or both. Commercial properties are typically leased by businesses, except in the case of multifamily rentals and apartments. 

Because they appreciate in value and have the potential to generate income for the owner, commercial properties are good investments. It’s a stable source of income too, one that doesn’t perform poorly even through market shocks. A major factor for this stability is that tenants of commercial properties often lease them for a longer period compared to residential real estate. And, the rental rates are higher too. 

However, despite these and other benefits, commercial buildings also come with some disadvantages. Let’s discuss several of them below. 

Higher Initial Investment or Cost of Ownership

Generally speaking, commercial properties are more significantly expensive than residential real estate. There are several factors contributing to this high price, including limited availability, prime locations, potential for higher rental yields, reputable tenant demand, and development costs.  

Even if it’s a small commercial property, it will still be expensive. Commercial property investors will need a substantial down payment and closing costs, not to mention other expenses necessary to lease and operate it. In other words, you will typically need a huge chunk of capital to buy a commercial property no matter the size. 

Because the upfront investment is significant, commercial property investors also shoulder the potential risk of losing a huge amount of capital.  

Bigger Renovation Costs

Shelling out money to purchase a commercial property is just one of the costs of owning one. Once you have a commercial real estate under your name, you still have to do tons of work to make the space suitable for leasing out. 

One such expense is renovation, the costs of which can stack up depending on the tenant’s needs. According to accounting software firm FreshBooks, you could pay less than $30 per square foot to more than $300 per square foot for renovating a commercial property. The actual cost will depend on several factors such as location, building codes, building use, building materials, and labor cost. 

In addition to high renovation costs, commercial property owners also need to ensure that the amenities, security, and parking needs of the tenant are met. 

Legal and Regulatory Complexities

The law is a complex subject and navigating it can be complicated. In fact, regulations surrounding commercial real estate is a major roadblock or hindrance to prospective investors. 

There are rules and regulations on purchasing, maintenance, and taxes, for instance, and they can differ from state to state. Legal requirements might also vary for different industries, zones, sizes, and zones, among others. The laws surrounding commercial leases are also stricter compared with residential lease agreements. 

If a commercial real estate investor is not careful, they could open themselves up to lawsuits and claims from not only tenants but also customers, employees, and contractors. That is why, most commercial property owners ask professionals who know their way around the law, such as lawyers and property management firms, to help protect their business.

More Intensive Property Management

Property management for a commercial property includes similar duties as those for residential property management. Commercial property managers also deal with tasks such as marketing, tenant screening, rent collection, and regular maintenance. But, imagine those duties on a much larger scale. 

Because of the property’s size and the number of tenants involved, the scale of operations is just much bigger compared to that of a residential property. So, property managers of a commercial real estate need to possess expertise for efficient management. 

Higher Maintenance Cost

As with any real estate property, regular maintenance of a commercial property is necessary to preserve its value, keep its functionality, and ensure safety in its premises at the very least. Ongoing management, upkeep, and repair of the property is also important for optimizing performance and complying with relevant laws and regulations.

However, unlike residential properties, commercial real estate might require the use of specialized services and equipment for maintenance and repairs. As such, the costs are higher. 

The average annual maintenance cost for commercial properties ranges from $2 to $2.50 per square foot, according to the International Facility Management Association (IFMA), the world’s largest international association of facility management professionals. 

These costs vary based on factors such as location, age, and usage. For instance, commercial properties used for retail have lower average annual maintenance costs at $1.50 to $2 per square foot. Meanwhile, those used as offices incur an annual average maintenance cost of about $2.15 per square foot, according to the Building Owners and Managers Association (BOMA).

Exposure to More Risks and Liabilities

Although a commercial property has the potential to earn more than a residential property, it does come with more risks and liabilities. 

Public Safety

A commercial property, especially one that is used for retail purposes, typically has more public visitors. With more people on the property daily, the chance that these individuals can get hurt or do damage to the commercial real estate is much higher. Even if the injury or damage is minor, such as someone slipping and falling or vandalism, it still represents a liability for the owner. 

Credit Risk

While commercial leases represent a higher amount and go for longer periods than residential lease agreements, the risk of non-payment is also greater. Because we’re talking about significant amounts of money here, a business with declining sales or which suddenly closes poses a huge financial risk for commercial property owners. 

Businesses who can’t pay their lease will impact not only the property’s income but also its value. Then there’s also the cost of litigation to collect rent.