Historically real estate has always been known as an excellent way to build wealth.
However, while both residential and commercial real estate can add to your net worth, commercial real estate has several advantages to investors seeking to achieve a higher rate of return on their investment.
The value of a commercial real estate property can be increased through forced appreciation
The value of a residential real estate property is typically limited to the value of the properties surrounding it. Thus, if the value of the properties in your location is around $250,000, you won’t be able to increase the value of the property by more than a few thousand dollars.
More than one investor has discovered this unpleasant fact after investing thousands in total kitchen and bath renovation.
The value of a commercial real estate property, on the other hand, is based solely on the cash flow generated by the property.
Of course factors like location do play a role, however there are additional ways to increase the value of a property, thereby directly affecting revenue.
Changing property management, upgrading to higher quality tenants, raising the rent, ensuring the property is being used for the highest and best use, and adding amenities are just some of the ways a savvy investor can force appreciation and increase revenue.
Fewer deals can make you more money
Residential real estate is brutally competitive. Everyone and their neighbor is intent on finding a fixer-upper or foreclosure, so these properties go quickly. And even if you manage to find a property that can sustain a higher rent, if you need to sell you still won’t get a sale price any higher than the other (lower rent) properties in the neighborhood.
Thus if you want to make a decent amount of money in residential you’ll need to constantly keep an eye out for good deals to add to your portfolio. Keep in mind that each potential deal will still need due diligence, renovation, and management,which places additional burden on an already busy investor.
Eventually you’ll reach a point where traditional lenders like banks will refuse to finance a new property. This is true even if you have an excellent record of returns. So if you decide to add another property you’ll either have to sell one of the ones you already own or go hunting for a private lender.
Commercial real estate, on the other hand, has fewer investors competing in the same space. There are a wider variety of property types, such as industrial, retail, office, and apartments, and within each property type there are also numerous sub-types to choose from.
Commercial income properties do cost more than residential, but due diligence is the same, and banks are much more willing to lend money for a high-performing commercial property than a residential. There also is no limit on the number of commercial properties you can own, assuming each one is netting a profit.
More financing options
Speaking of financing, it’s worth it to point out that loan terms for commercial properties are not only easier to get, but are often more flexible. Rather than coming up with all the money, you have a choice of sharing the cost with the bank, the seller, private lenders, equity partners, and any other combination you can think of.
Some types of commercial deals, such as a leaseback or triple net, ensure high quality tenants and a guaranteed sale – all at the same time.
Economies of Scale
If you own several residential real estate properties, you already know that each property needs to be managed separately as an individual unit. Any repairs or maintenance are also done as they come up for each property.
With commercial investment properties, once you have enough units to justify hiring a manager (usually upwards of 100 units) you can hire a manager. Whether you decide to give them a free apartment and a salary or you hire a property management company, you’ll still be out of the management game.
Instead of you being on call 24 hours a day, you’ll have a dedicated manager who will handle everything that comes up, calling you only in specific situations.
This is often hard to do with residential unless you’ve hit a certain number of properties, because the amount of money you make won’t be enough to justify the cost of a manager.
Maintenance also ends up being cheaper. Instead of having ten houses spread out throughout the city, you can hire one company to deal with all the work. Usually they’ll give you a discount because they’re getting steady work that pays well. And if you decide to upgrade your units it definitely comes out cheaper to buy the same tiles, paint, appliances, etc.
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