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Should You Invest in Residential Or Commercial Properties?
Most people in Northern CA start investing in real estate by buying their own home. And many have made money as real estate in Northern CA has continued to appreciate in value. So when they moved, they decided to rent their first house. And then they found a few more homes. They know they have no income but they are making a profit because of the appreciation. This is a common story of how many real estate investors are selling residential properties. So far luck is on their side.
As interest rates have risen slightly over the past 12 to 24 months while rents in the Bay Area have remained flat, the negative cash flow gap is widening. The risk of investing in residential properties increases. The same old investment formula may not work anymore. In the best case scenario, investors may make money but not much in terms of percentage because real estate prices are so high. In a worst-case scenario, investors may lose money as real estate may remain flat or even drop in value. Is there a solution for real estate investors in Northern CA? Of course, these investors can use the same old formula in a new area that can appreciate. So the key is to find this new place. They just need to talk to someone who knows this new place. It could be Bakersfield or Sacramento or Fresno. Besides, investors can invest in commercial properties: retail chains, shopping centers, medical office buildings. Let’s examine this paradigm shift to see if it makes investment sense.
1. Salary: 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: Generally, rental properties are more attractive to the landlord compared to residential properties. In addition to the base rent, tenants must pay the landlord for property taxes, insurance and all maintenance costs. These leases are called Triple Net or NNN leases. Because of this type of lease, commercial properties are maintained better than residential properties. Besides, NNN leases also remove many risks from the landlord as maintenance costs are unpredictable. On the other hand, landlords often postpone renovations on residential properties to reduce costs. As a result, deferred maintenance will have a negative impact on property values.
3. Better Residents: tenants of commercial properties are financially strong. They might be Walmart or Home Depot with billions of dollars in the bank. They are unlikely to nickel and dime you. In addition, they also guarantee the rental of their property. If for some unforeseen reason they have to move out of the property, they continue to pay rent or find another tenant to pay. They are also motivated to keep your property in good condition to attract their customers to their stores. While most residential tenants are nice, some think that once they pay the rent they have a license to dispose of your property and disappear into thin air without a shipping address!
4. Long term lease: commercial tenants rarely leave. They often sign employment contracts of 5 to 10 years. Tenants like Walgreens, and Walmart sometimes sign 20-50 year leases. In contrast, residential rentals are short-term. They could move to a new place 25 miles away for rent relief! It is true that the turnover rate for renters is very high compared to commercial tenants. As a landlord, this gives you unnecessary headaches and stress.
5. Administration: It is much easier to manage a shopping center with 10 tenants than 10 homes in 10 different locations. In fact, if you own 10 rental properties your tenants are probably tired of you and we are. They usually come out in the summer just about the time you want to go on vacation. Yes, it is true that residential properties have very high turnover due to high turnover rate. If you have to hire a property manager, it also costs more as a percentage of rent to manage residential properties. Besides, it can be a full-time job to manage these 10 property managers!
6. Income Tax Returns: it is much easier to keep track of records for income tax purposes for a 10-unit shopping center than for 10 rental properties in most areas. You should have one file in the shopping area 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. Your foreign income tax return is also thinner for a shopping center with 10 units than with 10 residences.
7. Exemption of Taxes: Commercial properties offer the same tax write-off, 1031 exchange as residential rentals.
8. Impact of credit scores: Most people don’t know that once they have about 10 home loans, their credit score will start to drop. The credit bureau causes that the credit risk is higher the more money you borrow and a 9-10 mortgage seems like a barrier. On the other hand, commercial mortgages do not have a negative impact on your credit score as these mortgages are not reported to the 3 credit bureaus.
9. Pride of ownership: most commercial properties are referred to by name rather than their address, for example Lion Plaza, or Valley Fair Shopping Center. They can be award properties that provide great pride of ownership. You get a lot of respect when you tell people you have a place to shop that they know.
10. Amount of investment: Commercial properties often require a large amount of money so they are not suitable for someone with a small amount of money.
So if you want to work hard with your money or bet on appreciation then invest in real estate. If you want to work smarter, follow the properties of the market. Real estate investing is a smart way to invest in real estate if you have extra equity for a down payment. Every month you have guaranteed cash flows so you don’t need to rely on just the price to make money. So if you haven’t invested in real estate, now you know why you’re not in the elite group of real estate investors. You are probably wondering where you should go from here if you want to explore this possibility further. In future issues, these topics will be discussed
o Which commercial property should you invest in?
o Need to invest in a commercial space?
o How to pick and choose the right commercial property
o What you need to know before hiring a property management company
If you can’t wait for those articles, you can sign up for a free seminar on Investing in Transmercial Marketing. 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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