Thursday, May 22, 2014
4 Strong Reasons to Invest in Commercial Real Estate
I realize that many of you reading this can't imagine yourself getting out of making small deals in residential real estate and moving into the commercial real estate arena. Quite understandable as many of us don't like change or have some fear of it.
What you need to realize is that in commercial real estate, it's not about your personal resources that matters but it's a reflection of the deal itself...IT'S EXACTLY ABOUT THE PROPERTY.
Cash flow is king! Commercial real estate when purchased right will produce much higher levels of cash flow compared to residential. This is intuitive, isn't it? Not really for some people because if you think about it for a moment, a single family home that needs renovations will produce zero cash flow. Additionally, your money is tied up until at least the renovation is over and if you're flipping a home after renovating it, you must factor in holding time again after the repairs are done. So, you could have zero cash flow for months or even years! (Yes, years!). Without cash flow, your business will grind down or even come to an abrupt halt.
Related to Reason #1, commercial real estate offers less risk when the right systems are put in place. If you lose a single tenant in a single family home, you have zero income but when you lose a tenant in a 100 unit apartment building, you've lost 1% of your total income. I'm sure you get the idea...
Building equity takes less time with commercial real estate. Bigger total payments from tenants mean your mortgage (if you have one) gets paid down in bigger lumps compared to residential rentals. Additionally, value appreciation over time also creates more dollars for you in comparison with residential.
Forced Appreciation - This one is the best of the lot if executed right. By increasing income and/or decreasing expenses, you can effectively increase the value of a commercial property by $10 for every $1 increase in income or decrease in expenses. This is an average value with the standard understanding that average investors are looking for a 10% rate of return on their investment. The powerful thing to take away from this is that $1 more in your pocket translates to a $10 increase in value....powerful stuff and very true!
i.e. this comes from the standard commercial valuation formula of:
Rate of Return = Income / Total Value
By re-arranging this formula, we get Total Value = Income / Rate of Return
and with our example the total value increase, assuming we want a 10% rate of return = $1 / 10% = $10.
If you need a primer on commercial real estate, you may want to pick up a copy of Trump University Commercial Real Estate Investing 101, which is written by David Lindahl with a forward by Donald Trump. It's a very good beginner's book and a great reference for the more seasoned professional that I highly recommend. Check it out below.