Should you invest in residential or commercial real estate?

Most people in Northern California started investing in real estate by buying their own home. And most have made money as Northern California real estate continued to increase in value. So when they move, they decide to rent out their first home. And then they acquire a few more houses. They know they have negative cash flow, but they make a profit through appreciation. This is the typical story of how most real estate investors invest in homes. Luck has been on their side so far.

As interest rates have gradually risen over the past 12-24 months while rents in the Bay Area have remained virtually flat, the negative cash flow gap is widening. The risk of investing in residential property is increasing. The same old formula of investing may no longer work. At best, investors can still make money, but not as much in percentage terms given that property values ​​are already quite high. In the worst case, investors could lose money as residential real estate could stay the same or even fall 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 potential for appreciation. So the key is to find this 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 invest in commercial real estate: high streets, malls, medical office buildings. Let’s take a look at this paradigm shift to see if it makes sense to invest.

1. Income: commercial real estate generates 50 to 200% more rental income compared to residential properties in the Bay Area. In addition, there is no rent control for business premises. So landlords can charge your tenants as much as the market allows.

2. Rental contracts: in general, commercial property leases are more favorable to the landlord than residential leases. In addition to the basic rent, tenants must also pay property taxes, insurance and all maintenance costs to the landlord. These leases are called Triple Net or NNN leases. Because of this rental form, commercial properties are better maintained than homes. In addition, the NNN leases also remove many risks from the landlord, as the maintenance costs are unpredictable. On the other hand, landlords tend to postpone maintenance on homes to reduce costs. Consequently, the overdue maintenance will have a negative impact on the value of the properties.

3. Better Renters: 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 do business with you. In addition, they also guarantee the lease with their assets. If they have to leave the property for unforeseen reasons, they continue to pay the rent or find another tenant to sublet. They are also motivated to keep your property in good condition to attract their customers to their stores. While the majority of residential renters are good, some think that once they pay the rent they have a license to trash your property and then vanish into thin air with no forwarding address!

4. Long Term Rent: commercial tenants move less quickly. They often sign leases of 5 to 10 years. Tenants such as Walgreens and Walmart sometimes sign leases ranging from 20 to 50 years. In contrast, residential rental contracts are short-term. They could move to a new place a mile away to get a $25 rent reduction! It is a fact that the turnover of residential tenants is very high compared to commercial tenants. This gives you as a landlord more unnecessary migraine headaches and stress.

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5. Management: It is much easier to manage a mall with 10 tenants than 10 individual homes in 10 different places. If you own 10 rental properties, your tenants have probably worn you out and we’re exhausted. They often move in the summer just around the time you want to go on vacation. Yes, it is a fact that housing is very management intensive due to the high turnover rate. Also, if you have to hire a property manager, it will cost more as a percentage of the rent to manage properties. Plus, managing these 10 property managers is probably already a full-time job!

6. Income tax return: it is much easier to keep records for income tax purposes for a 10-unit shopping center than it is for 10 separate rental properties in different states. You only need one file for the mall, while you need 10 folders for 10 rental properties. The job becomes more challenging 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 mall than for 10 rental properties.

7. Tax Depreciation: commercial real estate offers the same tax depreciation, 1031 exchange as residential rentals.

8. Impact on Credit Scores: most people don’t know that once they have about 10 home mortgages, their credit scores start to drop. The credit bureau reasons that credit risk is higher the more money you borrow and 9-10 mortgages seem to be the threshold. On the other hand, commercial mortgages do not negatively impact your credit scores as these mortgages are not reported to the 3 credit bureaus.

9. Pride in Property: most commercial properties are listed by name and not by their address, e.g. Lion Plaza or Valley Fair Shopping Center. They can be trophy properties that offer tremendous ownership pride. You get a lot of respect when you tell people that you own a particular mall 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, invest in housing. If you want to work smart, go for commercial real estate. Investing in commercial real estate is a more prudent way to invest in real estate if you have more equity for down payment. Each month you have strong positive cash flow, so you don’t have to rely solely on valuation to make money. So if you have not invested in commercial real estate, now you know why you are not in the elite group of real estate investors. You’re probably wondering where to go if you want to explore this possibility further. These topics will be addressed in upcoming issues

o In which commercial real estate should you invest?

o Where should you invest in commercial real estate?

o How to pick and choose a good commercial property

o What you need to know before hiring a property management company

If you can’t wait to read these articles, sign up for a free seminar on Commercial Real Estate Investment at Transmercial. San Jose Real Estate Investor Club (phone number 408-264-3198) occasionally offers a similar seminar for a small fee.