Commercial real estate can be quite profitable, but it can also be very challenging. Consider these facts before moving into commercial real estate.
So, you've been selling residential real estate and feel like you're ready to try your hand at selling commercial property. You figure that it is something somewhat familiar but also different enough to present new and unique opportunities. Well, you are right!
The world of commercial real estate differs in several key areas from that of residential real estate. If you're going to make the switch, then you should learn the differences between these two worlds. This post will go over the key differences between commercial and residential real estate for realtors looking to branch out beyond residential real estate.
The Bar for Entry is Higher in Commercial Real Estate
The nature of commercial real estate makes it a more profitable endeavor for realtors. However, because the job requires more math-intensive analysis and a strong business background, commercial realtors tend to have college degrees in business, hospitality, or finance. The average national salary for a commercial realtor is $85,000 a year vs. $39,000 a year for residential realtors.
Commercial Realtors Undergo More Intensive Training
Commercial realtors usually work for commercial brokerages. Commercial realty requires more analysis and knowledge than residential realty. At the minimum, commercial realtors need to be familiar with the following business and financial concepts.
Net Operating Income
Abbreviated to NOI, this term refers to a calculated estimation of a property’s profitability after operational costs have been subtracted out. Profitability is determined by obvious factors -- such as the income from your tenant’s rent.
However, other less-common factors add to a property’s NOI. This may include parking fees, vending machines, ATMs, and additional revenue-generating amenities found on commercial property.
Return on Investment
In real estate, the ROI is a calculation that gives you the measurement of a property’s value as compared to its cost. This is given as a percentage of the initial investment cost. To calculate a property’s ROI, take the profit and subtract out the initial cost. Then, divide that by the initial cost.
The cap rate estimates the annual profit a piece of commercial property may generate. It is a useful tool for comparing similar commercial properties’ potential ROI. To calculate the cap rate, take the net operating income (NOI) and divide it by its market value. This calculation delivers a percentage that can be compared to the cap rates of other properties.
Internal Rate of Return
The internal rate of return, abbreviated to IRR, is a useful metric that tells potential investors the growth rate an investment will return over time. Different from ROI, the IRR reveals the growth rate over time rather than a percentage of the initial investment after a period of time.
Commercial Realtors Don’t Technically Need a College Degree, But...
A college degree in business, finance, or hospitality will make you appear more attractive to potential brokerages in a highly competitive field such as commercial real estate. That is not to say that a highly experienced and knowledgeable residential realtor can’t make the switch to commercial real estate if they don't have a college degree. However, many potential candidates will have a bachelor’s degree.
Commercial Realtors Need a Detailed Understanding of Markets They Engage With
Residential realtors need to have a solid understanding of the housing market. Additionally, they should have at least a cursory grasp of industry-adjacent markets such as construction or materials. However, depending upon their niche, commercial realtors need to know the markets their tenants are connected with -- including supply chains, competitors, and other market factors.
A Quick Example...
The interconnected world of commerce makes understanding different markets and how they interact a must for commercial realtors. Let’s say you are a realtor looking to sell restaurant space in the new shopping center located in a suburban area.
You can't sell restaurant space to a prospective tenant if you can't talk about how tourism affects the area seasonally or how market research shows a demand for a specific type of restaurant. Do you know the alcohol distributor in this region? How close is this restaurant space to a food wholesaler? Are there local farms looking to partner up with regional restaurants? What types of retail are you looking to attract that complements a specific style of restaurant?
Commercial realtors should have a decent sense of economic fluency when discussing market-specific factors with prospective tenants. No matter your specific industry under the umbrella of commercial real estate, you are going to need to understand the commercial world that your prospective tenants inhabit to sell to them convincingly.
The Workplace Culture Varies Considerably
Residential realtors are used to working after hours and overtime to make sales, follow up on leads, and conduct market research. Residential realtors have a more chaotic schedule, but they also enjoy relatively greater control over how they conduct their business.
Many residential realtors are surprised to learn that commercial realtors operate under normal 9-5 business hours and aren’t expected to go beyond this. Commercial real estate workplace culture is more corporate in nature, whereas residential real estate workplace culture tends to be more relaxed. (Of course, these are generalizations. One can always find exceptions if they look hard enough.)
Commercial Real Estate Agents Have More Specialized Options
Commercial real estate realtors can specialize in a variety of commercial properties. Though there is some specialization in residential real estate -- such as apartments, duplexes, historical homes, etc. -- commercial real estate offers more in the way of specialization.
Any type of commercial property is a potential niche market. From retail and restaurants to skyscrapers, warehouses, and farmland, commercial realtors can become highly specialized in the types of properties they sell.
Project Management and Land Development
Commercial realtors not only can specialize in the types of properties they broker, but they also have more options in the specific tasks they perform. Commercial realtors can go beyond general brokerage and have the opportunity to specialize in project management and land development.
Under these roles, commercial realtors would see the entire process of developing a property. The scope of tasks is broad and goes from the initial purchase to planning, development, construction, and leasing to tenants.
Closing a Sale in Commercial Real Estate Takes Longer
Generally, the time it takes to close a residential real estate sale is between 30 and 45 days. Due to the nature of commercial real estate, however, closing a commercial deal can take as long as a year and never wraps up in less than two months. There are also fewer commercial properties than residential properties, so the market is more competitive.
A potential buyer must consider financial research on the profitability of the property as well as the location and proximity to other properties, amenities and businesses. Because of this, a commercial realtor will also have to function as a financial analyst, assessing the cost, benefits, and risks for potential buyers.
Of course, this is in addition to being a salesperson. However, for commercial real estate, the numbers and financial projections drive sales better than the charm and personality of the realtor. Though charm and character always help.
Here are a few more reasons why the process takes longer for commercial real estate.
Commercial Leases are Generally for Longer Periods of Time and Are More Stable, Profitable
Residential leases tend to be short. They can be as short as month-to-month but generally go year-to-year. Even a lease as short as a year would be a nonsensical proposition for a business looking for commercial property. Usually, commercial leases last between five and ten years. Depending upon the type of property -- such as a city skyscraper -- a lease could last twenty to thirty years.
Because the tenants are businesses and the leases are for more extended periods of time, the cash flow tends to be more stable than in residential real estate. Additionally, since there tends to be less commercial property available as compared to residential, a lower supply means higher demand.
This is one of the reasons why commercial real estate is more profitable than residential real estate. For investors looking to supply you with capital, commercial real estate investing is a more lucrative prospect.
Changing Trends in the Way People Work and Shop Is Having a Large Impact on Commercial Real Estate
People will always need a place to live. Because of this, the housing market has a built-in longevity to it. The details may change, and trends will come and go, but the need for living space will never go away. Drastic changes to the way we work and shop are affecting commercial real estate in ways that residential real estate is generally resistant to.
The Way We Shop
Brick and mortar retail space has taken a hit with the adoption of online commerce. This decline in the demand for retail space has been superseded by a need for warehouse space and transportation centers to sort and distribute commodities. Think Amazon warehouses and the like.
Commercial realtors must be sensitive to these changing trends. They must seek advantage and opportunity by adapting to our new post-industrial, post-manufacturing commercial ecosystem.
The Way We Work
The pandemic has propelled the necessity for remote work forward at a much faster rate than was anticipated before 2020. The need for large towering office spaces and sprawling warehouses is becoming rapidly obsolete. Once the bread and butter for prominent commercial realtors, these lumbering bygones of a previous area are being reclaimed, rebranded, and reconstituted.
Proximity, which was once essential for productive collaboration, communication, and efficiency, is no longer required for businesses to be successful. There is less emphasis on office space as there is an emphasis on the quality of workspaces. Commercial real estate developers need to come up with new and unique ways to reuse old spaces for new commercial pursuits.
A Case Study: the BOK Building
The BOK building, located in Philadelphia, is an excellent example of reusing old spaces for commercial purposes. Once a vocational high school, the early 20th-century building officially closed its doors in 2013. However, commercial real estate developers, seeking a unique new opportunity, bought the building and have essentially transformed it into a thriving business park.
The classrooms are rented out to artists, teachers, craftspeople, doctors, therapists, fitness instructors, lawyers, graphic designers, web designers, restaurants, and retail. Literally keeping the old school vibe, the developers had to do minor renovations on the look and appearance of the exterior and interior.
This is a perfect example of commercial real estate developers taking advantage of changing trends in a particular market to develop new, valuable spaces out of old pre-existing buildings. You must consider how the commercial real estate markets are shifting and evolving in response to changes in society and culture.
Are You Ready to Make the Switch?
This post has demonstrated how two seemingly similar industries are practically and functionally quite different. Commercial real estate is a more involved world than residential real estate. To put it simply, the bar for entry is higher for commercial realtors. They must demonstrate an integrated understanding of markets, economics, mathematics, and finance.
Not only are they salespeople, but they are also analysts, sociologists, market researchers, and -- perhaps most importantly -- opportunists who can read a market’s trajectory and make business decisions that reflect changing trends and customs.
This article isn’t meant to intimidate you. Instead, it is designed to challenge you to make the leap of faith and try your hand at an exciting, rich, and interconnected industry.
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