Understanding Your Investment Period in Commercial Real Estate
Investors often put their money into investment opportunities with a longer time horizon in order to earn high returns. But what if you are interested in being invested for a shorter time?
When speaking of investments in general, the most quoted advice that you would have encountered - keep holding if it is a stable investment. While it is a sensible piece of advice, you wonder what the harm is in getting invested for a shorter time. If it is stable enough, it will be worth the time for short-term investment as well. Let us weigh the pros and cons of widening and narrowing the investment period window in commercial real estate.
Short-term leases and their relevance in CRE investments
When speaking of investments in the real estate sense, it is crucial to understand what is meant by short-term. Short-term leases in owning or investing can be from 1 to 12 months. Anything more, and you start stepping into long-term territory. Short-term leases are a viable option when a property would rather stay vacant. Another fit option for short-term leases is if your investment is in markets where eviction laws are tough, and where the demand for space outpaces availability. Landlords have a larger pool of tenants to choose from. That means the asset in question probably remains occupied even if multiple short-term tenants exit the property.
A short-term lease has many benefits for both the landlord. Because the term is short and normally the rents are higher than similar long-term properties, it gives the landlord the flexibility to change the terms and conditions and the rental price. For a tenant, it makes sense to benefit from shorter leases - if there are constraints of any kind.
Where does a short-term lease fall short?
In spite of its benefits, real estate investments normally do not speak in favor of short-term leases. These are the reasons why:
- From the tenant’s side, short-term leases often mean higher rents. It also means that even if the tenant decides to stick around a bit longer, there’s no surety that the landlord won’t have finalized on another tenant for a longer term in the meantime.
- On the owner/landlord’s side, short-term leases have their own set of requirements to deal with. That includes advertising on a regular basis to hunt for constant occupancy, preparation of the space for new tenants, and the like. This problem becomes much more apparent if the landlord/owner is not working with a property management firm or a brokerage firm. During this entire process, the property might sit empty and be less useful than a glorified paperweight.
- Short or ultra-short-term leases are often not that appealing to lenders or potential purchasers of the asset. This, however, will depend on the type of the asset. A commercial office space or an industrial space can have a longer lease period than that of a multi-family residential space.
Long-term leases and their quirks
As explained n the sections above, the moment a lease goes beyond the time of one year, it enters into the realm of a long-term commitment. But typically, such leases often last for 3-5 years for commercial office spaces. For warehouses and special purpose commercial spaces, the lease period can often come close to double digits. Long-term-lease properties are less expensive for tenants when calculated on the same time frame as comparable short-term leases. They are easier to find as well. In markets where vacancy rates are around 5% or lower, it is not unnatural to see long-term leases being the norm. Landlords/owners have a better chance at securing a stable investment asset this way. The wealth growth in such kinds of investments mostly happens through capital appreciation as time passes.
A long-term commitment comes with its own challenges though. Most long-term leases come with a lock-in period as well. Breaking the lease within this period will incur financial consequences; where the rent for the entire lock-in period has to be paid upfront before vacating the property. Other restrictions can also apply based on the lease agreement. For the landlord/owner, a problematic tenant can be a handful if they are in a long-term lease, and there’s no management firm handling their assets. If market conditions change for the better, owners/landlords might feel left out since they cannot charge a higher rent.
Finding the balance
Traditional investing in CRE often places an investor in a dilemma between choosing short-term and long-term leases. Since all their money is parked in one or two assets, they can only move on to another more profitable asset if they find a buyer for the existing ones. However, through fractional ownership, investors can be part owners in multiple commercial properties and reap the benefits of returns without being tied down unnecessarily to underperforming assets or disagreeable tenants. If a property isn’t providing the returns you expect, you can easily auction off your share in the investment to another. That way, the lease still remains intact, and you can move on to a better asset.
Strata employs fractional ownership and intensive data-driven research to provide investors with Grade A assets to invest in. To know more about how we are changing the real estate investment space for the better, please get in touch with us at www.strataprop.com.