Commercial Real Estate Investing Vs Residential

Is commercial real estate investing a better investment than investing in residential properties? Now, we all know that real estate in general is a great investment vehicle and both residential and commercial properties can be good investments. Either avenue can have a tremendous effect on your net worth, but most people think only of residential property when they think about investing in real estate. While this is certainly the most viable route for most people, commercial property can offer additional benefits the residential model can not offer.

Three Reasons Commercial Investments are better than Residential Deals:

1.) Commercial Real Estate Gives You More Access to More Capital

It has been my experience that it is somewhat easier to raise larger amounts of capital (under $3M) for a commercial deal than it is to raise $150,000 for a residential deal. As a residential investor your access to capital is limited primarily to traditional financing, hard money lenders, and private money from individual investors. If you are unable to raise capital from one of these three avenues, then you are forced to acquire property in more of a creative manner with owner financing, subject to strategies, lease options, etc. This in itself is not a bad thing, but unfortunately you will have to walk away from some good deals that can’t be acquired with creative financing techniques.

In commercial real estate it is more common for investors to pool their capital together and syndicate deals, you will also find that smaller private equity firms and finance companies are more inclined to do joint venture projects and provide the needed capital to complete the deal if the deal makes sense. So as a commercial investor you have the potential to raise capital for a deal from the same sources as residential projects such as: Traditional Financing and Hard Money, but additionally you could access capital through smaller private equity firms, hedge funds, private REITs, investment groups, and the list goes on.

There also seems to be a sense of intrigue and prestige when it comes to investing in commercial deals. Perhaps, due to the state of the current commercial market, it appears investors are trending more toward investing in commercial projects.

2.) Commercial Real Estate is Less Competitive

When you think about it from a marketing perspective, most investors target residential property owners, thus making the residential market more competitive. In many arenas, from industry news sources, the World Wide Web, all the “We Buy Houses” signs virtually on every street corner, there are a lot of marketing tactics targeting residential property owners. If you take the same marketing strategies discussed and apply them to commercial real estate, you will probably find you are the ONLY person contacting these commercial property owners in regards to selling their property. Most commercial properties under $5 million tend to be too large for most residential investors, yet too small for most institutional investors.

3.) Commercial Real Estate allows for “Forced” Appreciation

Residential properties are typically valued based on other comparable properties that have sold in the area and are similar in features. If the “comps” for a 3 bedroom/2 bathroom house in a particular neighborhood is roughly $100,000, then your property is probably going to be worth $100,000. It doesn’t matter too much if your target property has additional features, or if your house is getting $900 a month in rent as opposed to the house down the street that is only renting for $700 a month. All things considered, your property will still be valued pretty close to the “comps” of the area.

However, in commercial real estate, the valuation of a property is based on the revenue that the property generates. Now, commercial properties are still subject to the “comps” of the area as it pertains to “How” that revenue is valued in terms of capitalization rates. But, the overall premise is that, the more revenue a property generates, the more that property is worth.

So, in order to “force” the appreciation of your commercial property, you need to find additional ways to increase the revenue that the property generates. A small increase in revenue can increase the value of a property significantly depending on the “Cap Rates” in the area for that type of commercial real estate. Unfortunately, with residential real estate this isn’t an option as you really can’t force appreciation. Your property will be valued in the general range of the market comps.

So, as you can now see, commercial real estate offers many benefits over residential investments in addition to higher returns on your investment.

Now of course there are disadvantages with any investment vehicle, commercial real estate included. However, consider the following when choosing between residential or commercial investing to create your passive income stream;

1) The building qualifies for the loan; Not the borrower

2) The building pays back the loan; Not the borrower

3) Others are expected to manage the building; Not the borrower

4) Income determines the value of the property; Not the comps

5) Cap Rate measures demand for the property; Not the comps.

To sum it up: a commercial property’s value is eternally tied to the income the property produces and overall demand for the property’s services. Therefore, based on the property’s location and the highest and best utilization, commercial real estate investments can certainly create a larger return on your investment over time verses residential investments. Perhaps, this is even more true in our current market cycle.