Investing in commercial real estate can generate outstanding returns. But, new investors often struggle to determine which type of commercial property makes sense. From apartments to office buildings to industrial sites and everything in between, investors face a variety of options. Understanding the pros and cons of each commercial property type will help you better analyze potential investment opportunities. As such, we’ll use this article to compare two property types, explaining the pros and cons of investing in multifamily vs office space.
Specifically, we’ll cover the following topics:
- Pros and Cons of Investing in Office Space
- Pros and Cons of Investing in Multifamily Properties
- Final Thoughts
Pros and Cons of Investing in Office Space
Office Space Overview
Office space includes the commercial properties tailored towards white-collar businesses. In terms of functionality, an office is largely an office, regardless of the particular building. As a result, instead of sub-categorizing this property type by function, investors break down office properties by 1) age, 2) condition, and 3) location. More precisely, investors use the following system to assess office buildings: Class A (newest, highest-quality, best location), Class B (mid-range), and Class C (oldest, in need of repairs, less desirable location).
With respect to location, office buildings broadly include the following:
- Central business district (CBD) properties
- Commercially zoned houses
- Suburban office buildings
Office Space Investing Pros
Moving an office can pose significant challenges to a business. In addition to needing to physically move your staff, furniture, and other equipment, relocating will inevitably disrupt your business operations. As a result, businesses typically sign longer leases than you would see with residential tenants. While every situation differs, it’s not uncommon for a business to sign a five- to ten-year lease for an office space. From an investor’s perspective, these extended lease terms provide stable cash flows and limited turnover requirements.
Furthermore, many office buildings have multiple tenants (though single-tenant offices certainly exist). This trait provides another key advantage to this commercial real estate type; if one tenant vacates an office, the other tenants often shield the landlord from a major cash-flow hit.
Office Space Investing Cons
Due to its business focus, office space performance closely tracks the broader economy. When the economy performs well, occupancy remains high and office property investments perform well. However, this characteristic also speaks to one of the largest disadvantages to investing in office space. In a downturn (or pandemic), office building performance – particularly Class B and Class C – tends to suffer.
Another downside to investing in office buildings involves placing tenants. People pick up and move all the time. Businesses tend to move less frequently. Accordingly, placing a tenant in a vacant office can take far longer than simply finding someone to rent an apartment, which often leads to longer vacancy periods between office tenants. For this reason, many lenders impose a 10% vacancy loss assumption when underwriting a mortgage on an office building (as opposed to the 5% vacancy loss standard with multifamily properties).
Lastly, offices pose familiarity challenges to many investors. At some point in time, we’ve all rented an apartment, so we inherently understand tenant needs and lease agreements. But, many investors have never had to sign a commercial lease for an office, meaning they have less inherent familiarity with office tenant needs and the commercial lease process. This unfamiliarity can be overcome with the help of a commercial real estate broker to assist with the lease process, but investors should still recognize the potential drawback.
Pros and Cons of Investing in Multifamily Properties
Multifamily commercial real estate consists of residential properties with multiple, distinct units. Technically speaking, two- through four-plexes qualify as multifamily. But, from a financing perspective, lenders generally categorize these types as residential real estate.
Conversely, when apartment buildings have five or more units, they qualify as commercial real estate. As such, investors typically use commercial lending when debt financing these buildings. While not an all-inclusive list, some of the more common types of multifamily properties include:
- Garden-style apartments
- Mid-rise apartments
- High-rise apartments
- Student housing / dorms
- Senior and assisted-living
Multifamily Investing Pros
One of the major advantages to multifamily properties is familiarity. Even if people never invested in an apartment complex, they have likely lived in one at some point in time. As a result, an inherent familiarity exists between landlord and tenant. That is, an apartment owner likely understands the needs and general profile of a tenant, which lets these owners better support their tenants.
Furthermore, apartments have a major cash-flow advantage over some other commercial property types. Whereas losing a single industrial tenant could collapse a landlord’s cash flow, it’s not all-or-nothing with multifamily real estate. When you lose a couple residential tenants, the income from the other units helps offset these vacancies. For example, in a 50-unit apartment building, two vacancies likely won’t prevent you from making your monthly mortgage payment.
Multifamily Investing Cons
But, this advantage to apartment buildings relates directly to the main disadvantage of this commercial property type: high turnover. Many apartments offer month-to-month or yearly leases, meaning tenants come and go frequently. In addition to the vacancy-related costs, these turns also have a direct labor and maintenance cost. When someone moves out, the landlord (or management company) needs to clean and paint the apartment, and they need to market the unit to place a new tenant. These turnover costs can make up a large portion of a building’s operating expenses.
Final Thoughts on Multifamily vs Office Space Investing
As illustrated, pros and cons exist to both of these property types. For investors looking for longer lease terms with more stability, investing in office space may make sense. On the other hand, investors seeking to minimize vacancy periods with tenants whose needs they understand, multifamily investing may be a better option. However, it’s important to note that these investment options are not mutually exclusive. Benefits exist to a diversified real estate portfolio, and some investors choose to have both multifamily and office exposure.
If you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about available passive real estate investment opportunities – both multifamily and office.