Investing in real estate is one of the wisest financial decisions you can make in your lifetime. Naturally most people first think of residential real estate when they consider acquiring an investment property. They know how the purchasing process works, the rental agreements are basically very simple, and the “perceived” entry costs are relatively low.
However, commercial has all the benefits of residential investments, but offers a MUCH higher rate of return, with fewer headaches, more protective leasing agreements, and more ways to make money.
The Difference between Commercial and Residential Real Estate
Residential real estate normally refers to properties leased to individuals or families for living accommodations. The underlying asset is commonly a single family home, condominium, or townhouse, but the term “residential” can also refer to small apartments typically sub-divided into four or fewer units (like duplexes, triplexes, etc.) Landlords should consider a tenant’s income, credit rating, rental history and other factors indicating that the tenants will properly care for the property.
Commercial real estate investing is business focused. There is a much wider variety of commercial property types, including retail, office, warehouse, multifamily (5 or more units), manufacturing, and so on.
Think of commercial real estate like running a business: the property is an asset that can be purchased, leveraged, leased and sold at a margin to achieve the investment criteria of the investors. The objective is to create a return on investment (ROI), calculable with a high degree of accuracy based on market conditions and pricing.
With all these benefits and safeguards, investing in commercial real estate beats residential properties 10 out of 10 times! Here are 10 reasons why you should invest in commercial real estate.
1. Less Competition
The residential real estate market is extremely crowded with investors. Unless you are a real estate agent yourself or have an inside scoop on finding deals, it will be difficult to “come across” a property with the potential for high, short-term yields.
Commercial properties are everywhere, but there are much fewer investors. The deals are evaluated from a purely business perspective, and many people feel unqualified to pursue financing or evaluate a contract.
At Commercial Academy, we offer a collection of online tools like our 7 Move Quick Check that will help you quickly understand whether to consider moving forward with a deeper commercial property evaluation or pursue another opportunity more aligned with your personal and professional goals.
2. Much Bigger Profits
Most of the time, residential property values are tied to comparable properties within the neighborhood. Unless you can talk the seller into a fantastic offer, for all intents and purposes your profit ceiling will be limited on a residential property.
The value of a commercial property is determined by the current and projected net operating income and cash flow. The “comparable sales” valuation model that exists in residential real estate cannot apply to commercial properties because the variety, square footage, and use types are extremely varied. It wouldn’t make sense to value a gas station and an office building on a per-square-foot basis, even if they were right across the street from each other.
Banks estimate the property’s future viability by considering location, competition, and the borrower’s financial credit rating. When you increase the net operating income of a property by recruiting new tenants or raising rents, banks are willing to increase the market value of the underlying asset anywhere from 8x to 12x your net operating income (depending on the market).
This means huge equity returns for you, and bigger profits in the long run!
3. Less Risk and Less Emotion
Residential real estate can be a highly emotional transaction. We’ve all seen people who “fall in love” with a house and are willing to overlook obvious flaws and risks in the property. Often, a buyer becomes willing to pay more for the house than they probably should, which can ultimately affect comparable values in the neighborhood. This could be good news for owners, but not great for investors.
Commercial real estate is valued solely on its capacity to generate cash flow and investment returns. The underlying condition of the property at the time of sale should be assessed very carefully, and any safeguards against undetected risks should be written very clearly into the purchase contract.
Because a commercial property is not a “home,” the transactions can be evaluated from a much more rational, financial perspective. This reality enables you to separate the winners from the losers! (Check out our proprietary online Opportunity Evaluation Tool if you want to know whether an offer is worth pursuing.)
4. Forced Appreciation vs. Single Family Comps
Residential properties are appraised based on the value of similar properties in the surrounding area. Although a high-paying tenant may increase the desirability of a property when selling to another investor, the value of the underlying asset (which represents your equity) fluctuates very little when compared to the surrounding market.
Property appreciation in commercial real estate is based on profitability and not comparable sales of similar properties. As an investor, you must complete your due diligence regarding the relevant market trends that could affect the future value of the asset. But keep in mind that by increasing the net operating income of the property, you force the property to appreciate in value.
There are numerous ways to increase net operating income: cutting costs, raising rents, reducing your tax obligation via capital improvements, and so on. Because a commercial property is valued like a business (and not a residence) every increase in the net operating income results in HUGE gains to the value of the property.
The financial principle that SUPERCHARGES your appreciation is called the market capitalization rate. You can learn more about the capitalization rate on our website.
5. Passive Income
Who likes to earn cash without managing or doing anything? This is a reality for commercial real estate investors: True passive income.
Many of my students are skeptical about this point. They don’t believe that you can take a hands-off approach to your investments. But it’s absolutely true.
On account of the higher property values you often control in commercial real estate, many investment options offer the latitude to hire a property manager. For example, if you purchase a 24-unit apartment complex, you can “hire” a property manager for next to nothing by offering them a unit in the complex. When problems come up, it is the job of the property manager to manage and fix them. Meanwhile, you are earning the cash flow from renting the remaining 23 units. Is this opportunity cost worthwhile? You bet!
Which leads into the next point…
6. Less Turnover
One of major pain points in residential investing is the high turnover rate. Many tenants are hesitant to sign multi-year leases because they know that their lives and circumstances will probably change. They could get a new job, have another child, respond to a family situation…it’s rare that a single house will be suitable for an individual or family for more than 12-18 months.
On the other hand, the average length of a commercial lease is 3 to 5 years, and it’s not unusual to structure a lease to last 10 years. Remember that your tenants are other businesses and it’s less likely that they will want to move frequently. Consider the surrounding market factors and competition around your property. Many business tenants are willing to make a long term commitment.
7. Fewer Headaches
Because tenants in commercial properties tend to be other businesses who are looking for long-term commitments, they are more inclined to take care of your property. In an office building scenario, for example, business leaders want their workplace to be an attractive environment and a positive reflection of the company.
Any costs in improving the commercial space–like painting, flooring, bathrooms, etc.–are almost always covered by the tenant. Furthermore, if you have multiple tenants in a single property, they collectively pay for building repairs to common areas, parking lots, utilities, taxes and any other costs associated with proper upkeep and maintenance. These expenses are typically rolled into their rental payment, and can be adjusted from year to year.
8. Leasing Structures
If you own a residential investment property and the roof leaks, whom will the tenant call first? Yes, YOU. (Unless you have already sacrificed a significant chunk of your slim margin to hire a property management company.)
Commercial leases are structured in a totally different way. When a repair is required, the tenants pay for it. This arrangement is called a “net lease.” In a net lease, the tenant pays for additional expenses, including property taxes, insurance premiums, repairs, and so on.
There are different types of net leases depending on which expenses are bundled in with the rental payment. A “single net lease” requires that the tenant only pay property taxes in addition to their rent. A “triple net lease” requires that the tenant pay ALL additional expenses and absolves the owner from virtually all costs associated with owning the building (usually in exchange for a lower rental payment).
You can learn all the tactics and strategies for choosing the right lease for your tenants in our courses at Commercial Academy. We even have document templates to help you manage your properties.
This point is so obvious that I almost didn’t bring it up. The next time you’re in conversation with a residential investor, ask them about the last time they had to enact eviction proceedings. It’s a total nightmare for an investor!
Depending on the state, When a residential tenant becomes delinquent, they have to be served with an eviction notice. A court date is set. The eviction has to be legally granted, and then the bailiff comes within two weeks. All the while, the tenant may be destroying your property.
In commercial real estate you have much more latitude. Often times you can work with tenants, restructure their overdue payments, or find other solutions to achieve a win-win outcome before terminating their lease.
Evicting a commercial tenant immediately can be short-sighted because it could cost hundreds of thousands, if not millions of dollars to replace the tenants. It’s best to figure out what’s really going on and analyze their problems to find a good solution. A market survey comparing your property to other comparable properties in the area can yield valuable insights to achieve a positive outcome.
10. More access to capital
Because Commercial Real Estate is solely geared toward generating a return on your investment, many more people and institutions are willing to finance your deals…even sellers!
Seller financing in residential real estate is extremely rare. This makes sense because the margins are generally very low and sellers would not want to assume all the risks of taking on residential tenants without a potentially higher return rate.
However seller financing is much more common in Commercial Real Estate! This massively reduces the barrier to entry! Seller financing simply means that the seller is going to find a creative way to reduce the amount of capital you have to bring to closing. Seller financing can take many forms: the seller can loan you the down payment (a loan that can be forgiven later!), contribute the down payment themselves in exchange for more favorable finance terms, or take on a single “wrap around mortgage” to restructure the obligations on the property.
There are so many amazing strategies and tactics for acquiring and financing commercial real estate with very little money required at closing. These deals can be structured in such a way that you receive a six figure check when you buy, and a seven figure check when you sell!
Commercial real estate offers you more access to capital than any other real estate investment vehicle.
You can learn all these financing strategies and tactics at one of my 3-day LIVE Events.
In the past, commercial real estate was an exclusive industry reserved only for the “billionaire types.” But in modern times, equal access to financing and capital has created opportunities for everyone.
YOU can learn to make huge profits and passive income in this incredible industry.
If you are interested in learning more about the lucrative opportunities awaiting you in the dynamic commercial real estate industry, be sure to check out our online courses and tools at Commercial Academy.
Want to attend a 3-day live event? Commercial Academy LIVE offers everything you need to know to maximize your profits and earn massive amounts of Passive Income. Click here to see our upcoming events.