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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 profited as Northern California real estate values continued to rise. So when they move, they decide to rent their first homes. And then they get a few more homes. They know they have a negative cash flow, but they are making a profit because of the increase in value. This is a typical story of how most real estate investors invest in residential real estate. So far luck has been on their side.
Since 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 investment formula may no longer work. In the best case, investors can still earn, but not so much in terms of percentage because the property value is already quite high. In the worst case scenario, investors may lose money as residential real estate may remain unchanged or even decrease in value. Is There a Solution for Northern California Real Estate Investors? Of course, these investors can use the same old formula in a new area that has the potential to increase in value. So the key is to find that new area. They just need to talk to someone who knows this new area. It could be Bakersfield or Sacramento or Fresno. Alternatively, investors can put money into commercial real estate: retail streets, shopping malls, medical office buildings. Let’s just explore this paradigm shift to see if it makes investment sense.
1. Income: commercial properties generate 50 to 200% more rental income compared to residential properties in the Bay Area. Additionally, there is no rent control for commercial properties. So landlords can charge your tenants as much as the market allows.
2. Leases: In general, commercial real estate leases are more favorable to landlords compared to residential leases. In addition to the basic rent, tenants must also pay the landlord property taxes, insurance and all maintenance costs. These leases are called Triple Net or NNN leases. Because of this type of lease, commercial space is better maintained than residential space. In addition, NNN leases also remove many risks from the landlord as maintenance costs are unpredictable. On the other hand, landlords tend to postpone the maintenance of residential properties in order to reduce costs. Consequently, deferred maintenance will have a negative impact on property value.
3. Better tenants: tenants of business premises are financially stronger. They can be Walmart or Home Depot with billions of dollars in the bank. They are less likely to make money with you. In addition, they also guarantee the rent with their property. If for some unforeseen reason they have to leave the property, they continue to pay rent or find another tenant to rent it to. They are also motivated to keep your property in good condition to attract customers to their stores. While most residential tenants are good, some think that once they pay their rent they have a license to destroy your properties and then disappear into thin air with no forwarding address!
4. Long-term rental: business tenants are less likely to relocate. They often sign leases for 5-10 years. Tenants like Walgreens and Walmart sometimes sign leases for 20-50 years. In contrast, residential leases are short-term. They could move to a new place a mile away and get $25 off their rent! It is a fact that the turnover rate of residential tenants is very high compared to commercial tenants. As a landlord, this creates more unnecessary migraine headaches and stress for you.
5. Management: It’s much easier to manage a mall with 10 tenants than 10 individual houses in 10 different locations. In fact, if you own 10 rental apartments, your tenants have most likely exhausted you, and we are exhausted. They often move out in the summer just when you want to go on vacation. Yes, it is a fact that residential real estate management is very intensive due to the high turnover rate. If you have to hire a property manager, it also costs more in terms of percentage of rent to manage residential properties. Plus, it’s probably a full-time job just managing these 10 asset managers!
6. Income tax declarations: it is much easier to track income tax records for a 10-unit shopping center than for 10 separate rental apartments in several states. You should only have one file for the mall, while you will need 10 folders for 10 rental apartments. The task becomes more demanding because the IRS requires you to keep records for several years. Your out-of-state income tax return is also thinner for a 10-unit shopping center than for 10 rental apartments.
7. Tax write-offs: commercial properties offer the same tax write-offs, 1031 exchanges as residential rentals.
8. Impact on credit scores: Most people don’t know that after they have about 10 home mortgages, their credit scores will start to drop. The credit bureau reasons that the more money you borrow, the higher the credit risk, and the threshold seems to be 9-10 mortgages. On the other hand, commercial mortgages 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 referred to by name rather than address, for example Lion Plaza or Valley Fair Shopping Center. They could be trophy properties that offer tremendous pride of ownership. You get a lot of respect when you tell people that you own a particular mall that they know.
10. Investment size: commercial real estate often requires a significant amount of money, so it is not intended 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 housing. If you want to work smart, look into commercial real estate. Investing in commercial real estate is a more prudent way to invest in real estate if you have more capital 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 if you want to explore this possibility further. These topics will be discussed in the following issues
o Which commercial properties should you invest in?
o Where should you invest in commercial real estate?
o How to choose a good office space
o What you should know before hiring a property management company
If you can’t wait for those articles, you can sign up for a free commercial real estate investment seminar at Transmercial. 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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