Residential vs commercial real estate investing; which is better? You’re about to discover an in-depth comparison of the pros and cons of residential and commercial real estate investing, with details you’ve probably never considered, so you can decide which type of real estate is right for you:
Residential vs Commercial Real Estate Investing: Pros and Cons
Pros of Investing in Residential Real Estate (Duplex, Triplex, Fourplex)
Plenty of Supply – a property is considered residential up to a fourplex which means residential investment properties are plentiful.
Easy to Finance – One of our proteges recently purchased a fourplex with no money down. All he was required to do to get the loan was pay the closing costs. Typically with residential real estate, down payment requirements can be as low as 0% down or as high as 15%. The financing of residential real estate is a powerful pro for investors.
Get Started Quickly – Since residential investment properties are plentiful and easy to finance, you can start investing immediately.
Cons of Residential Real Estate Investing
Scaling Limit – As a general rule you can only get 10 residential investment loans in your name at a time. So you do have a scaling limit with residential investing.
Can’t Force Appreciation – No matter how much you increase the rents on your four unit, it does not increase the value of the property. It’s value is based solely on the sales comparables in the surrounding neighborhood. A fourplex or triplex is valued just like a single family home.
Pros of Commercial Real Estate Investing
Scalability – Your first multi-family investment could be a 32 unit apartment. Just one purchase out scales a fourplex by eight times. And even as a beginner, you can go from zero to 32 with just one deal. So, with commercial real estate you can scale much faster.
Forced Appreciation – With commercial real estate you can force the appreciation on your property. As you raise the rents, your cash flow and your NOI goes up, increasing the property value. At Commercial Property Advisors, we teach our students strategies to force the appreciation on their property and create immense wealth.
Bigger Paydays – After a couple years of raising the rents, you can refinance with a cash out refi and pull out big cash. You can get big paydays in commercial real estate.
Cons of Commercial Real Estate Investing
Larger Down payment – The down payment is more substantial in commercial real estate. The minimum is 20%, however it is usually 25% and can be even higher. It just depends on the numbers in the deal.
Run As a Business – Commercial real estate needs to be run like a business and this could be considered a con for some investors. However, anyone can learn how to operate commercial investments like a business. In fact, that is one of the components of commercial investing that we teach our students. So, commercial investing requires more work to be successful than residential.
Residential vs Commercial Real Estate Investing
Forced Appreciation Comparison
Forced appreciation is our bread and butter at Commercial Property Advisors. Our students have achieved financial freedom by creating wealth forcing the appreciation on their properties. The following comparison will demonstrate why this strategy is highly successful with commercial real estate.
Commercial: 48 Unit Apartment
One of our Protégé Students recently purchased a 48-unit apartment. This property has rent upside potential and he will increase the rents by one hundred dollars over the next couple years.
$100/month x 48 units = $4,800/month x 12 months = $57,600 per year in additional income.
To calculate the increased property value, divide $57,600 by the cap rate in the area. The cap rate in the area of our student’s property is 6%. After he has increased all the rents he will have $960,000 in increased property value.
Residential: 4 Unit Property
Another one of our proteges purchased a 4-unit residential property. Using the same scenario of raising the rents by one hundred dollars over the next couple years, we can compare the impact forced appreciation has on both commercial and residential real estate.
So what if our student raised the rents $100 a month on his four unit?
$100/month x 4 units = $400/ month x 12 months = an additional $4,800 per year.
Now that the income has increased almost $5,000/year, how has that boosted the property value? Unfortunately, with residential it has done nothing to boost the value of the property. Again, with a four unit, it is valued the same way any single-family home is valued. Raising the rents has zero impact on the property value. Its value is based on what other comparable residential properties in the neighborhood have sold for. So if your property is in a neighborhood where similar residential properties are increasing in value, then your property is worth more. But if it’s not, if the market is stagnant or going down, your residential property will track with those trends.
Exit Strategy Comparison
Determining your exit strategy is a crucial aspect of investing in real estate and it is often overlooked. There are three basic exit strategies.
- Long-term Hold.
- Cash-out Refinance
- 1031 Tax Deferred Exchange
Long-term Hold: When comparing residential and commercial real estate as a long term investment, commercial investing is the winner. You can make huge sums of money if you can hold onto a commercial property long term. We never flip commercial properties. Our strategy is to purchase commercial property, increase the rents and make them cash flow, build up wealth, and get the tax benefits for maximum wealth creation. So in terms of long-term hold as an exit strategy, commercial real estate wins hands down.
Cash-Out Refinance: The easy winner when executing this exit strategy is commercial real estate. You can force the appreciation on your commercial investments, and then pull that money out by refinancing with a cash-out refi.
1031 Exchange: This is a powerful wealth building tool. With this exit strategy commercial investors purchase a property with upside potential, fix it up, force the appreciation and increase the property value, sell it, and then exchange into a larger property using a 1031 Exchange, deferring the capital gains taxes. To learn more about using a 1031 Exchange to build your commercial real estate portfolio, watch my video here: 1031 Exchange Step by Step Case Study
Property Management Comparison
Passive Management: When comparing managing residential or commercial real estate, which is more passive? Well, neither is the winner in this category because they both require work. As an investor you need to be a good steward of your investment. Both residential and commercial investments require managing different aspects of the property to maximize the performance of the property.
Systematic Management: Which one can be managed systematically? And which one can investors scale to create more cash flow? Can the owner of a four-unit property afford an onsite manager and staff to help build the business? With a residential property, there isn’t enough income to do that. A 48-unit apartment generates enough income to hire a third-party manager with the staff to maximize the performance of the property and then execute an exit strategy. That’s how you scale your business to great heights. So commercial real estate creates more cashflow and is more systematic than residential.
Creating Generational Wealth
Finally, when comparing residential and commercial real estate, which has the potential to produce retirement income or build legacy for you and your family? Considering the scalability of commercial real estate plus the ability to force the appreciation, commercial real estate wins at creating generational wealth. And proof of the power of commercial real estate is all the investors we have mentored at Commercial Property Advisors. They have used commercial real estate investing to build a financial future for their families.
Discover how you too can create generational wealth with commercial real estate through our Protégé Program: Protege Program Details
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