The Property Diversification Dance

Diversification into commercial property

If you already have a major portion of your property investments tied up in residential real estate, it’s always a good idea to consider some form of property diversification.  Like any asset class, diversifying can be a great way to help weather any downturns in a given sector of the market.  With so many large fund investors (who acquired foreclosures by the thousands in the past few years) beginning to sell off a large portion of them on the market while prices have risen in the past year, looking at the commercial sector to invest in now makes good sense, since prices will surely stabilize in the residential arena due to the sell-off.

Office buildings

If you look at office space as just one sector of the commercial market, there are numerous advantages over residential buildings.  Since offices tend to have a much greater number of tenants, there is a built-in diversity to the type of tenants you will have in place.  In addition, their lease time frames will all be different, and the leases will, on average, be much longer than any residential lease could be.  It’s usual to see five to ten year leases in commercial space.  Compare that with the typical one year lease in residential property, and you’ll quickly see some of the advantages of not having to constantly be soliciting, screening and installing new tenants each year – per unit.  And with a wide variety of tenants, if one leaves, it won’t affect your bottom line as adversely, or as quickly as in residential real estate.  In addition, the types of companies you attract may be larger firms, with proven track records of doing business.  So their singular lack of risk of default, or of their going out of business, will greatly aid your cash flow in the long run.  Thus, commercial property can afford you a higher chance of bringing in consistent income streams.

REIT’s

As mentioned in prior articles here about Real Estate Investment Trusts (REIT’s), if you’re not looking to own “bricks and mortar” pieces of commercial property, then investing in REIT’s that specialize in the commercial building niche make sense for you.  While some funds lean more towards retail space (large enclosed malls, strip malls and stand-alone shops), and others towards office buildings, most will invest in some combination of the two.  Some may specialize in medical office space, others in warehouse buildings.  But all will diversify within a particular set of commercial buildings.  Still others will keep a mix of commercial and residential buildings, mostly apartment houses of varying sizes and locations.

More benefits of commercial investing

Besides the advantages listed above, consider the fact that commercial property makes a great hedge against inflation.  Since commercial leases tend to include annual inflationary rent bumps in them, you don’t have to worry about your rent rolls not keeping up with inflation.  In addition, your property values will increase over time due to these lease-inflation bumps.  And finally, consider that historically, commercial property tends to have less volatility in market valuations than residential real estate.

 

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