You probably see dozens of TV commercials and social media ads promoting rental properties as a source of long-term passive income. Rental rates have been increasing over the past few months, thanks to the Fed deciding to raise interest rates to clamp down on runaway inflation.

However, many investors are not too sure whether buying a rental property is the right choice. The rising mortgage interest rates are also weighing heavily on people’s minds at this time. However, there are many factors that go into deciding when to buy a rental property.

In this blog, we will consider the pros and cons of investing in commercial rentals and how to make the right decision.

1. The Advantages

Income Potential

Commercial rentals have a rate of return of 6% to 12%. It is large enough for you to cover mortgage payments and management costs while generating a steady profit. Office rents have been increasing once again and vacancy rates are dropping. In the weeks and months to come, demand for commercial rentals is expected to return to pre-pandemic levels meaning higher potential returns for investors.

Tax Benefits

You are eligible for a number of deductions as a rental property owner. This includes property tax, insurance, and depreciation among other closing costs. You can even defer capital gains taxes on the purchase of commercial property via a 1031 exchange. The deductions increase the amount of capital you have available to trade up into bigger properties.

Price Appreciation

According to Bloomberg, commercial property prices rose 23% in 2021. As demand picks up, prices are expected to continue their rise depending on the economic and regulatory scenario and the condition of the asset. 

Post-pandemic, secondary markets have started to show a sharp increase in property prices as demand shifts from traditional hubs. Research shows that companies are choosing to move to smaller cities as they are cheaper.

The Disadvantages

Maintenance costs

You may have to spend as much as 50% of your rental income on repairs and maintenance every few months. These are unavoidable if you want to preserve and grow the value of the property. This is apart from emergency repairs due to natural calamities like storms and floods.

Poor Liquidity

Commercial real estate suffers from poor liquidity. You can get a mortgage or loan to finance business needs. However, it can take time for banks to disburse the funds and with the added burden of service fees and other charges.

Tenant churn

In a slow market, you may find it hard to attract and keep tenants. At times, tenants may fail to pay their rent on time which may force you to evict them. It might take weeks for you to find another one during which time your property could well remain vacant.

Last Words

If you would rather avoid the hassles of managing rental property, a Delaware Statutory Trust (DST) may be a great alternative. It allows excellent opportunities for diversification and growth. But there are also issues to consider with direct real estate ownership. However, rental properties are not risk-free.

Make sure you work with an experienced financial advisor to ensure that your investment strategy is aligned with your financial goals and risk profile. True North can provide the insights you need to invest strategically in an uncertain environment. Contact us for more information.