Choosing between the two and understanding commercial real estate.
Many so-called “experts” will claim that investing in real estate (or businesses) is superior to other investments. The majority, though, only have experience with the one they suggest. It’s crucial to fully comprehend both before making your first investment, allowing you to decide the best option.
It is the part wherein we will talk about investing in commercials.
Definition
Commercial real estate includes companies’ buildings and the land they sit on. Offices, stores, factories, hotels, apartments (5+ rental units), self-storage facilities, mobile home parks, etc., are all included in this.
Saving and Making money
Commercial investments typically produce more cash flow per square foot than residential investments. It means it is far more profitable. This significant difference is one of the main reasons why many people invest in commercial real estate.
Furthermore, commercial leases (other than apartment leases) are typically much longer (often 5 to 20 years versus one year). Therefore, it typically results in a more consistent and reliable income stream.
Commercial real estate, on the other hand, is not without drawbacks.
The Thorn in Every Rose
Commercial investing has traditionally required much more significant capital than residential investing. A typical investment could cost millions rather than a few hundred thousand. Commercial projects of a larger scale can cost hundreds of millions of dollars.
Banks typically require 30 percent or more down, making funding more difficult.
Due to these factors, only the wealthiest investors could previously afford to invest in a commercial. That is now changing. Due to the development of real estate crowdfunding, practically every accredited investor can now participate for as little as $2500. (Learn More About Real Estate Crowdfunding.)
Crowdfunding will eventually be available to all investors when minimums are even lower. As a result, this is becoming less of an issue.
Storm Surge
The other major disadvantage of commercial real estate, on the other hand, is unlikely to go away. The retail real estate market is much more cyclical and volatile than the residential one.
Before the Great Recession, there had never been a nationwide downturn in residential real estate in nearly 100 years (the last time was the Great Depression). In contrast, the commercial has a down cycle every eight years. That’s more than ten times the volatility.
As a result, it is critical to get the right time for commercial investments.
Additionally, every type of asset has a distinct cycle, which may be very different from the others.
Apartments, for example, are nearing the end of their life cycle, whereas industrial properties are just beginning. Additionally, the national process may be slightly ahead or behind each geographic market.
Therefore, keeping track of these factors and considering them when making any commercial real estate investment is crucial. It takes much more research than the typical residential real estate investment (Search What the Real Estate Cycle Is?) to make this kind of investment.
Economic Risk
During a recession, not all asset classes are created equal. Some are more vulnerable to a downturn than others.
In previous cycles, for example, hotels (lodging) were the most volatile (first to get hit, fell the farthest, and stayed down the longest). On the other hand, mobile home parks and multifamily have historically been much more stable.
However, there is one significant caveat to the preceding. An excessive amount of new construction close to a property you purchase can easily ruin the fun and turn a historically safe asset class into a very risky one.
Many would argue that this is already taking place in many self-storage and senior housing markets (in many primary markets and downtown areas with multifamily). Therefore, you must be knowledgeable of the dangers of the unknown. And to reduce the possibility of a nasty surprise, a wise investor does their due diligence at the property level.
The fact that manufactured homes, or mobile home parks, are so despised by locals makes them particularly advantageous in this situation. As a result, supply is kept low. On the other hand, because everyone is aware of this and the market is so fragmented, finding good deals is very difficult.
It’s all about Timing
Because of the issues mentioned earlier, timing is critical. Understanding the asset class and keeping up with current trends is crucial.
Power centers, for example, were once trendy in the retail industry. However, as the Internet and e-commerce became more popular, these are no longer the sure bets they once were. On the Internet, many businesses, including Marcus and Millichap and the Urban Land Institute, provide this essential analytical information for free.
Debt versus Equity
As an investor, you can invest in commercial real estate with either equity or debt.
A lease, which can be single net, double net, or triple net, can provide income. Single net requires you to do the majority of the maintenance. The tenant is solely responsible for supervision under a triple net. Resulting in a low-maintenance investment that, when done with high-quality credit tenants, can be as safe as a bond.
Which is better, in the end?
Many people will tell you that residential investment is superior to commercial investing (and vice versa). So which of the two real estate types—residential or commercial—is the best? There isn’t a universal solution to this that works in all situations. The answer is dependent on your investment objectives, risk tolerance, and where we are in the cycle.
Homework and knowledge requirements are lower for residential real estate, which also carries lower risk. However, the returns are lower. While the returns on commercial real estate are much higher, it is also much more volatile. It calls for a deeper understanding to make wise decisions.
Why make a decision?
Choosing between the two, in my opinion, is a mistake and a relic of a bygone era. It made sense for many investors to focus on just one of the two before the advent of crowdfunding to acquire all the necessary knowledge. But since both can now be purchased, I think a properly diversified portfolio needs both.
Commercial real estate generates higher returns, but it is more volatile. Therefore, when the commercial real estate cycle is favorable, I favor it in my portfolio. However, as it ages and approaches the end of its life cycle, I invest in residential real estate. If both appear overheated, I transfer assets to cash or other alternative investments.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.