I often maintain that investments in residential real estate is much safer than commercial real estates as long as the leveraging is manageable, and that the yield from the property can cover the mortgage payment. In a slow or contracting economy, people must still have a place to need so residential real estate’s rents, as long as they are priced attractively, will be able to find a renter. Of course, that assumes the residential area has sufficient population and that the area is not vastly overbuilt. However, for commercial real estate, the renter must turn a profit in order to support the rent. Therefore, the landlord must price the rent low enough for the renter of the commercial space to turn a profit. But rent is just one of the cost factors of a business, among many other things such as labor costs, inventory costs, promotion costs, etc. There is no gurantee that a business can turn a profit even if rent is free. Thus, the margin of safety for commercial space is much lower.
In the past year, most of the focus on real estate problems has been primarily residential real estate. However, in 2009, I believe much of the focus will be turned to commercial real estates. The folllowing blog entry describes the situation very well.
When commercial real estates busts, other than all the big banks, a lot of smaller community banks will be hurt as well, as they are popular lenders for developers. We shall see how this unfolds in the following year.
