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Should You Invest in Residential Or Commercial Properties?
Most people in Northern California started investing in real estate by buying their own homes. And most of them made money as Northern California real estate values continued to rise. So when they move, they choose to rent their first homes. And then they get a few more homes. They know they have negative cash flow, but they are making a profit because of the appreciation. This is a typical story of how most real estate investors invest in residential real estate. So far, luck has been on their side.
As interest rates have gradually increased over the past 12-24 months while rents in the Bay Area have remained very flat, the negative cash flow gap is widening. The risk of investing in residential real estate is increasing. The same old investing formula may no longer work. At best, investors can still make money, but not as much in percentage terms, since the value of the property is already quite high. In the worst-case scenario, investors may lose money as residential real estate may remain flat or even decline. Is There a Solution for Northern California Real Estate Investors? Of course, these investors can apply the same old formula to a new area that has the potential for appreciation. So the key is to find this new area. They just need to talk to someone who knows this new field. It could be Bakersfield or Sacramento or Fresno. Another option is for investors to put money into commercial real estate: strip malls, shopping centers, medical offices. Let’s explore this paradigm shift to see if the investment makes sense.
1. Income: commercial properties generate 50-200% more rental income than residential properties in the Bay Area. Additionally, there is no rent control for commercial properties. That way, landlords can charge your tenants as much as the market allows.
2. Rentals: in general, commercial real estate leases are more favorable to landlords than residential leases. In addition to the base rent, tenants must also pay the landlord property tax, insurance and all maintenance costs. These leases are called Triple Net or NNN leases. Because of this type of lease, commercial properties are better maintained than residential properties. In addition, NNN leases remove a lot of risk from the lessor, as maintenance costs are unpredictable. On the other hand, landlords tend to postpone the maintenance of residential properties in order to reduce costs. As a result, deferred maintenance will have a negative impact on property values.
3. Better tenants: tenants of commercial real estate are financially stronger. They could be Walmart or Home Depot with billions of dollars in the bank. They are less likely to make money off of you. In addition, they also guarantee the rental with their property. If for some unforeseen reason they have to vacate the property, they continue to pay rent or find another tenant to sublet it. They are also motivated to keep your property in good condition to attract their customers to their stores. While most residential tenants are good, some people think that once they pay rent they have permission to trash your property and then disappear into thin air with no forwarding address!
4. Long-term rental: commercial tenants are less likely to relocate. They often sign 5- to 10-year leases. Tenants such as Walgreens and Walmart sometimes sign 20- to 50-year leases. In contrast, residential leases are short-term. You could move to a new place a mile away and get $25 off your rent! The reality is that the turnover rate of residential tenants is very high compared to commercial tenants. As a landlord, this causes you more unnecessary migraine headaches and stress.
5. Management: It is much easier to manage a mall with 10 tenants than 10 individual homes in 10 different locations. In fact, if you have 10 rental apartments, your tenants are most likely wearing you out and we are exhausted. They often move away in the summer just when you want to go on vacation. Yes, it is a fact that residential property management is very intensive due to the high level of turnover. If you have to hire a manager, managing a residential property is also more expensive in terms of a percentage of the rent. Plus, it’s probably a full-time job just to manage those 10 property managers!
6. Income tax announcements: it is much easier to track income tax records for a 10-unit shopping center than 10 separate multi-state residential rentals. You should only have one file for the mall, while you will need 10 folders for 10 residential rentals. The task becomes more challenging as the IRS requires you to keep records for several years. Also, your foreign tax return is thinner for a 10-unit mall than for 10 residential rentals.
7. Tax write-offs: commercial properties offer the same tax write-offs, 1031 exchanges as residential rentals.
8. Impact on credit scores: what most people don’t know is that after they have about 10 home mortgages, their credit score will start to drop. The credit bureaus claim that the more money you borrow, the higher the credit risk, and the threshold appears to be 9-10 mortgages. Commercial mortgages, on the other hand, do not have a negative impact on your credit scores because these mortgages are not reported to the 3 credit bureaus.
9. Pride of Ownership: most commercial properties are listed by name rather than address, such as Lion Plaza or Valley Fair Shopping Center. They can be trophy properties that offer tremendous pride of ownership. You get a lot of respect when you tell people you own a certain mall they know.
10. Amount of investment: commercial real estate often requires a lot of money, so it is not for someone with a modest amount of money.
So, if you want to work hard for your money or bet on appreciation, then invest in residential real estate. If you want to work smart, reach for commercial real estate. Commercial real estate investments are a more prudent way to invest in real estate if you have more equity for a down payment. You have strong positive cash flow every month, so you don’t have to rely solely on appreciation to make money. So if you haven’t invested in commercial real estate, now you know why you’re not among the elite group of real estate investors. You’re probably wondering where you should go from here to explore this option further. These topics will be covered in future issues
o Which commercial real estate should you invest in?
o Where to invest in commercial real estate?
o How to choose a good commercial property
o What you need to know before hiring a property management company
If you can’t wait for these articles, you can sign up for Transmercial’s free commercial real estate investment seminar. The San Jose Real Estate Investor Club (phone number 408-264-3198) occasionally offers a similar seminar for a small fee.
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