Commercial Vs Residential Investing – 3 Reasons Why Commercial Real Estate is Hot
When individuals consider turning to real estate as an investment vehicle, folks tend to think residential real estate to expand their net worth. I would say that primarily this is because it is what they know and are familiar with, being homeowners first themselves. Nevertheless, commercial real estate is an equally powerful tool that offers additional benefits that many folks don’t realize.
Here are 3 reasons why you should consider commercial:
1.) Commercial Gives You More Access to More Capital
It is often easier to raise large amounts of capital for a commercial deal (under $3 M) than to raise $125,000 for a residential deal. As an investor in residential your access to capital is limited to traditional financing, hard money lenders and private money from other interested investors. These are the traditional sources available to the residential investor.
With commercial real estate, on the other hand, it’s quite normal for investors to pool their capital and syndicate deals (legal term for pooling). It’s also not uncommon for boutique equity firms and finance companies to joint venture in these deals when they make sound investment sense, giving you greater access to larger reserves of money than you could come up with on your own. Therefore, you have the traditional residential financing resources available to you as well as the deeper pockets of commercial financing options.
2. ) Commercial Real Estate is Less Competitive
There is a nice pocket in the commercial world that makes it the perfect niche for smaller investors. Commercial properties under $5 million tend to be too large for the traditional residential investors, ie intimidating, but too small for traditional institutional investors. If you target this area, you will find little competition.
Anecdotally, you’ll notice on the off ramps of your interstates very few “We Buy Commercial” signs. Another indication that commercial is less competitive.
3.) Commercial Real Estate allows for “Forced” Appreciation
In the residential real estate world, house values are determined by comparables in the neighborhood. If the area comps out at $150,000 for a 3 bedroom / 2 bath house then that will dictate the value of your property, give or take a small percentage change for special upgrades perhaps. No consideration is given to how much you are renting the property for, or what the rents are for other properties.
Conversely, with commercial the value of the property is directly correlated with the revenue generated by the property, and not really subject to the comps of the area at all. Therefore, the more income the property can produce, the more it is worth. This is generally defined as the cap rate or capitalization rate. 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, making your property’s value always subject to area comps.
So, the ability to “force appreciation” of your commercial property will stem from how creative you can be in increasing revenue sources. For example, you could purchase a C Class building, upgrade it through renovation, start charging higher rents and thereby turning it into a B or A Class Building. You’ll be able to sell it for a significant profit using this strategy.