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3 Reasons Why You Should be Investing in Commercial Real Estate

by Khary Reynolds on August 9, 2010 · 11 comments

  
why commercial real estate is worth exploring

This is my first post on The BiggerPockets Blog and I just want to state that in my opinion, investing in commercial real estate is a better investment than investing in residential real estate. 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 that residential real estate can not.

3 Reasons Commercial Real Estate is Better than Residential Real Estate

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 real estate investor you have the potential to raise capital for a deal from the same traditional sources as residential real estate i.e. Traditional Financing and Hard Money, but in addition to that you can have access to capital through smaller private equity firms, hedge funds, private REITs, investment groups, etc.

There also seems to be a sense of intrigue and prestige when it comes to investing in commercial real estate. I have found that individual investors tend to be more impressed with the possibility of investing in a commercial project more so than a residential deal. Definitely not a fact, just something that I have noticed….

2. ) Commercial Real Estate is Less Competitive

Now in all honesty I can’t quantify this claim with hard-core stats, however, in my experience, for every real estate investor I meet, REIA meeting I attend, or real estate website I visit, the overwhelming trend is toward residential real estate. You always see “We Buy Houses” signs, every once in a while I see a “We Buy Apartments” sign, but you never really see any “We Buy Retail Shopping Centers” signs. I’m sure they probably exist though.

When you think about it from a marketing perspective, most investors target residential property owners, thus making the residential market more competitive. Just take a look at the “Investor Marketing Forum” here on BiggerPockets, most threads discuss 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 that 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 real estate is typically valued based on other comparable properties that have sold in the area that 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 that you have additional features, or that 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, you 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 real estate is 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 generated, 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.

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

Now of course there are disadvantages with any investment vehicle, and commercial real estate definitely has its disadvantages. However, there is not enough time to delve into them with great detail in this post, but we can always carry the conversation over into the comments below so please let me know your thoughts and comment below.

Comments are always welcomed and encouraged! Let me know your thoughts below in the comment section and feel free to retweet this post on Twitter.

Photo: Pedro Kwezi

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{ 11 comments… read them below or add one }

Eric Watts August 9, 2010 at 2:12 pm

Great Post! It amazes me that interest rates are in the lower 4s and that sales have not increased, or are not as increasing as fast, as the inventory of homes. In my market alone inventory is up approx. 66% since the begining of the year but of course some is attributed to the real estate business being a syclical business. Suppose consumer confidence still isnt where we would like it to be. Thanks for sharing, a very enjoyable read.

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john ainsburough August 9, 2010 at 2:56 pm

wow – you mean #1 isn’t that the gov’t will bail it out with tons of free money because it’s owned by the same people that own everything else? man i guess you’re really bad reasons might be right.

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Taylor White, PHD August 10, 2010 at 4:16 pm

I agree with the LARGER loan amounts.

I believe it was Trump who said that if you are having trouble with your $1,000,000 loan that is YOUR problem.

If you are having trouble on your $100,000,000 loan that is THEIR problem.

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Khary Reynolds August 11, 2010 at 11:24 am

Thanks for the comment Taylor. Larger deals definitely seem to attract more willing partners. I can’t wait until I get to the $100M level so I can put Trump’s theory to the test! :-)

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Eric August 11, 2010 at 8:18 am

Great post! I can definitely see why there is a lot more competition for residential. Fortunately, there’s just so many houses and condos out there that there’s room for plenty of investors to make money. Of course, those who are actually good at it will make the most though. One point that I do have to disagree with is that pulling extra rent of having extra features in a home won’t increase its value. This is in direct conflict to the principle of substitution and the income capitalization approach. If a buyer is looking at two houses, one with more features and can rent out for 28.5% more revenue than the same house down the block, you better bet that person will not be willing to pay the same amount for both places. Especially in this type of market where investors are running so many of the deals, the income approach should be emphasized more heavily. Given a stable cap rate, this would mean value must increase.

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Khary Reynolds August 11, 2010 at 11:31 am

Thanks for the comment Eric. The residential market in my area is actually pretty brutal. Although there is an abundance of homes on the market alot of the REO’s and fixer uppers go pretty quick and regularly there are bidding wars in the acquisition of these properties.

As far as the valuation concept, you are right that investors might not be willing to purchase the home that generates less rent for the same price as the home that generates more rental income, but by the same token, the house that generates 28.5% more rental income will rarely sell for 28.5% higher than the other homes in the neighborhood. There will still be a limit to how much that home will be able to sell for and the price will be in the general vicinity of the the other homes in the neighborhood.

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Curtis Gabhart August 15, 2010 at 3:50 pm

Khary,

Good post and some good points. As an ex commercial realtor who now only focuses exclusively on syndicating real estate deals I like commercial (apartments primarily). As far as syndication go they are easier for me because I don’t usually have to do As many commercial deals as residential for me to make more money.
With that being said I am not the most important person in the sypyndications my investors are and that is why at this moment we are not buying any commercial deals. My market is San Diego and we are eyeing a few markets we may go into for apartments over the next 12 months. It’s just to hard now to find very many distressed deals to buy that are GOOD deals. As the past president of the commercial realtors board and a board member of the local CCIM I am still in tune with the market and many of my best friends are Commercial REO brokers that I talk to weekly about deals….
In the meantime we have went back to flipping homes and trying to increase the scale of our buying by using micro funds with the intent of taking the investors into commercial when the time is right.
So I agree with your point about commercial being good just not right not. The other point that is probably as important is experience. If you haven’t done quite a few commercial deals you are not going to get many people who want to be your guinea pig and it’s probably best to build up from houses to apartments to other commercial and not try to make the mistake I see people do all the time in trying to git a grand slam without being up to bat much. You end up striking out and if you strike out in this business to soon you may be out of the game.

Great post and keep them coming.

Curtis Gabhart

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Khary Reynolds August 15, 2010 at 7:54 pm

Thank you for the comment Curtis. I would have to agree that your investors should ALWAYS be your number #1 priority and you should operate with their best interests in mind. However, I do believe the commercial real estate is very diverse and consequently there are always good deals to be acquired. The section of commercial real estate and the location of the real estate can vary but someone is always making a profit in real estate, and the only question that an investor must ask themselves is “Will it be me?”

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Troy Barford August 15, 2010 at 7:48 pm

I agree that there is definitely a future in commercial property investment but it’s not for the faint hearted or in my humble opinion a beginner in property investment. If you have plenty of funds it’s not the same issue, with a diverse portfoliuo you can spread your risk. The major issue for those on a lower budget is often the return or cash flow. Many commercial properties have long term and valuable tenants but when a commercial property becomes vacant it can take a long time to replace the tenants. How often do you see commercial premises remaining vacant for months on end. So all though generally commercial property investement gives you a greater return it comes with a wgreater risk.

Troy Barford

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kris February 10, 2013 at 1:53 pm

Certain commercial deal, we can’t increase income. Such as NNN Walgreens, they pay same rent for 75 yrs!!!! So what happens to future values???!!!! Thanks

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Rohit Yadav February 15, 2014 at 10:45 pm

Very nice post. Real estate is good option for investment. If you are thinking about investing Real Estate in Gurgaon than go for Emaar mgf palm drive.

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