Owner-Occupied Commercial Real Estate: The Pros and Cons
Owning commercial real estate comes with tax, financial and other benefits. Many businesses across industries choose to purchase owner-occupied commercial real estate, so they can realize these diverse benefits. Here’s a look at what owner-occupied commercial real estate is.
What Does Owner-Occupied Commercial Real Estate Mean?
Owner-occupied commercial real estate is a property that’s both owned and used by the same business. The business usually needs to use at least 30 or 50% of the property, depending on the specific program being considered. Most programs also consider properties that are used and owned by distinct entities within a single umbrella business to be owner-occupied.
Most types of commercial real estate can qualify as owner-occupied commercial properties. Retail stores, medical offices, office buildings, industrial buildings and flex space can all be owner-occupied. So too can specialty properties, such as those used for self-storage facilities, assisted living/skilled nursing facilities, daycares, event centers, sports stadiums, and more.
Multifamily properties are one exception that’s not recognized as owner-occupied. Hotels and various mixed-use spaces can be classified as owner-occupied, though.
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What Are the Pros and Cons of Owner-Occupied CRE Property?
Owner-occupied commercial real estate properties aren’t right for every business. These properties have many advantages that make them worthy of consideration in most instances, though.
Owner-Occupied CRE Advantages
The benefits of owner-occupied commercial real estate include both financial and other benefits.
- Build Equity: A portion of the monthly mortgage paid on owner-occupied CRE goes toward the mortgage’s principal. The amount of principal that’s paid of is turned into equity, which grows slowly over time as a loan is repaid. In contrast, lease payments don’t generate any long-term equity.
- Capitalize on Appreciation: Should an owner-occupied commercial property’s value appreciate, the appreciation can greatly boost a business’s assets. The added property value can be realized by selling the property, or by executing a cash-out refinance. Businesses benefit from any appreciation regardless of whether they own a property outright or have used financing.
- Rent Vacant Space: Vacant space in the owned property can be rented, either for the short-term or long-term. Any rental income received can be treated as additional revenues.
Renting out vacant space can be an especially effective tactic for growing businesses. Extra space can be temporarily rented while it’s not needed, and the payments received can be directed to spur further growth. The leases don’t have to be renewed once the space is needed.
- Reduce Taxes: Certain expenses related to owning and maintaining a property can be written off when a business owns the property. Property taxes and mortgage interest don’t qualify as write-offs when a business is leasing. Since there are many costs associated with maintaining commercial real estate properties, the tax deductions are frequently quite substantial.
- Control Property: When a business owns the property that it’s in, the business can do with the property as it wishes. There aren’t any constraints placed by third-party property owners that must be adhered to. Additionally, businesses may be more willing to invest in valuable upgrades if they’ll see the increased value whenever the property is sold. (Laws and codes, of course, still apply.)
- Stabilize Payments: if an owner-occupied property is financed through a fixed-rate mortgage, then the monthly payments for the property will remain constant for the duration of the mortgage. For businesses that don’t own property, monthly lease payments can jump every time a lease has to be renewed.
- Diversify Assets: For businesses that have substantial assets, investing in owner-occupied commercial real estate could offer a way to diversify the business’ holdings.
The disadvantages of owner-occupied commercial real estate primarily relate to the added work involved, although there are some others to consider:
- Maintenance: Simply maintaining a property can become a significant time sink. Maintenance of commercial real estate should be outsourced to reduce how much time is spent on non-core tasks. However, business owners are often still surprised at how much work is involved with maintaining commercial real estate.
- Tenants: When extra space is rented to tenants, renting or leasing presents a variety of hassles and risks. Businesses must be willing to find new tenants and respond to existing tenants’ calls/emails. Businesses also may need higher general liability insurance limits and some rent-specific insurance coverages.
- Capital: Owning property requires a sizeable capital investment in an asset that doesn’t directly yield business growth. Even financing property usually requires 20% down, which can easily be tens of thousands. Growing businesses may not have the capital needed to purchase property, or they might not want to tie up so much capital that could otherwise more directly promote further growth.
- Depreciation: In the unlikely event that an owner-occupied property depreciates, the owning business would have to sustain the loss.
Owner-Occupied vs. Non-Owner-Occupied Commercial Real Estate Loans
Whether a property is financed through an owner-occupied or commercial real estate loan depends solely on whether the owning business uses a sufficient amount of the building. When an owner-occupied loan is available, it’s usually more advantageous than a non-owner-occupied loan.
Lenders tend to consider owner-occupied commercial real estate to be slightly lower risk, as businesses are more invested in the buildings that they both own and use. OOCRE loans tend to have higher loan-to-value, lower credit scores, and lower debt-service coverage ratio limits. These loans also frequently have minorly lower interest rates, assuming all other variables don’t change.
The most advantageous owner-occupied commercial real estate loan is usually the SBA 504 loan program, which requires that a business uses at least 50% of a property’s space. Conventional owner-occupied CRE loans require that businesses use only 30%, and still good terms.
Is Owner-Occupied CRE Right for You?
Owner-occupied commercial real estate requires a capital investment, and a willingness to do extra work. If you can manage the financial and time investments required, however, owning the property that your business uses can be highly beneficial. The financial rewards alone can be large, and other considerations are also important.
Wrapping Things Up
Ultimately, you must determine whether your business should own commercial real estate. Base your determination on what your business needs now and in the future. If you see the benefit in controlling your business’ space and supplementing its revenues, then owner-occupied commercial real estate might be right for your business.