While it’s common to begin in real estate investing with single family homes, some investors eventually move on to commercial real estate investing, which they see as a natural evolution of their business. However, these two types of real estate investing are different in as many ways as they are similar.
Valuations Are Calculated Differently.
While the market value of residential real estate is largely driven by factors such as desirability of the neighborhood and recent comparable sales, commercial real estate values are much more closely tied to cash flow multiples. Location still plays an important role, but the cash flow of the commercial building, based on square footage, tenancy rates, and the number of tenants is what drives the value of the property. This method of valuation is much closer to have a non real estate business would be valued, and differs vastly from the way residential real estate values are determined.
Know Your Market.
Investing in residential real estate is fairly straightforward because the properties aren’t specialized. Generally, these are single family homes, or maybe duplexes, that don’t require much creativity if you need a quick exit strategy. When dealing with residential properties, there are almost always buyers or tenants available, at the right price. This helps protect your downside.
However, with commercial real estate, because the properties are often specialized, the same market and liquidity that is found with residential properties is not available for commercial properties. One potential pitfall to avoid is purchasing a specialized commercial property built for an industry of which you have no knowledge or only limited knowledge. For example, if you have no experience in leasing warehouse space, purchasing a large warehouse may not be the best first step in your commercial real estate venture.
It’s Time to Expand Your Real Estate Vocabulary.
Commercial real estate has a language all its own. You can think of each property as a business, complete with a profit and loss statement, much like a brick-and-mortar business has. You’ll need to become familiar with concepts and terms such as net operating income, cap rates, loan to value percentages, common area maintenance, and other terms which are specific to commercial real estate investing.
Wait for the Right Opportunity for You.
Because of the risks of investing heavily in specialized commercial real estate, You’ll want to wait until there’s an opportunity with a property that matches your experience or expertise. Through your experience in that area, you may already have built a network of professionals who can help you market or manage the commercial space. If your network needs expansion before buying a certain type of property, begin networking. Success in commercial real estate investing takes time and patience. Think of it as a marathon, rather than a sprint.
Location is important for commercial real estate, but for slightly different reasons than with residential real estate. Values for residential real estate can be heavily influenced by factors as granular as neighborhoods or school district. With commercial real estate investing, generally, neighborhoods aren’t as important, nor are school districts a concern. However, the general Trend in the city or municipality should be a strong consideration. Some commercial real estate investments may seem like a great deal based on price per square foot, but if the city or municipality is in decline and businesses are moving away, who will rent your space? There are cities scattered across the country with nearly empty business districts or industrial parks. Commercial real estate values in these areas are depressed due to a surplus of space relative to prospective tenants.
If you started your real estate investing career with residential real estate, and are now considering commercial real estate, it’s often best to keep some residential properties in your portfolio while you begin to add commercial properties. In a perfect world, commercial real estate investing can be more profitable than residential real estate investing, but it’s safer to have a mix of both due to volatility and rental markets and the possibility of long vacancies between tenants for your commercial properties. In the end, you often make money by not losing money and Keeping your real estate portfolio diversified helps to protect your growing real estate investment business.
For more information on successfully investing in Commercial Real Estate, contact Speritas Capital Partners today!