Commercial vs. Residential Real Estate Investment

Which Is The Best Investment

Residential real estate investment, I think it's fair to say, would be the investment of choice for most real estate investing neophytes. The question is however, is investing in residential real estate better than investing in commercial property? Does it make sense for someone that has never bought any investment property to jump right into commercial real estate investing?

The answer is, it depends. And most of all, it depends on you.

First, let's have a look at what constitutes commercial and residential real estate.

Defining Commercial And Residential Real Estate Investment

It would be logical to assume that a property that people live in would be considered residential real estate, whereby property that is used to conduct commerce or business would be considered commercial real estate. And for the most part that is true. The exception I suppose, would be multifamily properties and apartment complexes that contain more than 4 units. These type of properties are also considered commercial properties along with office buildings, warehouses, retail strip malls and the like.

To summarize, residential real estate consists mainly of single family homes, duplexes, triplexes, and fourplexes. Everything else is typically considered commercial.

Why I Quickly Made The Switch To Commercial

My first two real estate investments were residential properties. A townhouse and single family home, both bought and rented out for long term appreciation. Neither investment would be what I call "stellar" but both made me a nice profit over time. The problem with them, and this is true of most single family homes, is that they did not produce any positive cash flow. In fact, there were many months where I had to "feed" them cash.

Aside: It is not uncommon to have a negative cash flow when renting out single family homes with a high LTV (loan to value). The biggest drain on cash flow will be the mortgage payments. Therefore, if you want to earn positive cash flow from this type of rental you will likely have to come up with a larger down payment.

It was shortly after buying these two properties that I switched my investment focus from residential real estate investment, to commercial real estate. The main reason?

CASH FLOW

I learned quickly that you cannot live "today" on future appreciation. When I first started out investing in real estate 15 years ago, the ink was still wet on my MBA degree. At the time I had made the conscious decision to commit full time to starting my own real estate investment company. As such, that company had to generate income for me to live on. Buying break-even and negative cash flow properties and holding them for future appreciation would not work. I needed a new strategy.

At the time I belonged to a real estate investment club in my city. It was through that club that I met another gentleman who inspired me to turn my focus to commercial real estate. Over the previous 18 months before I met him, he had acquired several millions of dollars worth of multi family real estate (townhouse complexes and apartment buildings) and other commercial real estate. Within those 18 months he had created a monthly positive cash flow of over $15,000 for himself.

My interest was "piqued".

I immediately turned my focus from residential real estate investment to commercial property, and within 12 months had bought my first commercial building.

Some Of The Benefits Of Commercial Real Estate Investment

Cash Flow

As I stated above, the big attraction to commercial real estate for me was the potential cash flow. I say potential because buying any old commercial property with a high LTV does not automatically entitle you, the investor, to a positive monthly cash flow. But, if you buy the property correctly (ie. below market value, double digit cap rate, potential to force appreciation) you do have a great chance to succeed, make a profit and generate healthy monthly cash flows.

If this discussion has piqued your interest, but you are not sure where to start, I recommend an inexpensive course by a colleague of mine that deals specifically with commercial real estate investing, cash flow and funding. This is the kind of course I would have loved to get my hands on 15 years ago! You can get a copy here.

Ability To Add Value

My first commercial property was a four story, 53 unit building. It had 45 residential apartments on the top three floors, an elevator, and approx. 15,000 square feet of commercial space on the main floor, divided into 8 units. More importantly, I was able to buy the property at a 20% discount to market value with a double digit cap rate. In addition, within 12 months I was able to add an additional 25% in value to the property.

Remember, you make the most money the day you buy real estate, not the day you sell.

Ease Of Management

I was a little hesitant to use the word "ease" when describing the management of real estate because it is not typically "easy". However, unlike residential real estate investment properties, commercial properties have an expense for property management built right into the valuation of the property. Again, if you buy the property correctly, your cash flows can and will cover the cost of professional property management. I highly recommend that you keep a close eye on your properties but let your managers handle the day to day management.

Buy Out Of Town

Keeping with the theme of management, because you can typically afford to pay other people to manage the day to day operations of your properties, this allows you to look further afield for good deals. In fact, I have found my best deals far from where I live. This increases the amount of deals I can look at and therefore increases the chances that I will be able to locate deals that fit my investment parameters. Owning residential real estate investment properties scattered across the country would simply not be feasible.

Economies Of Scale

As I noted above, that first commercial property I invested in had 53 units. It took me about 8 months from the time I began searching for commercial deals until I closed on that property. To research, find, evaluate, finance and close on 53 individual residential real estate investment properties would have taken me years. By putting all the units under one roof I was able to save myself a lot of time and effort.

Lower Cost Per Unit

The cost "per door" of a twenty unit apartment building will be significantly less than the average cost of twenty single family homes in the same neighborhood. However, in most cases the rents you can command for one of the apartment units will not be that much less than what you could get for a home. For example, if a twenty unit apartment cost $1 million $50,000 per door, and a single family home nearby cost $200,000, it is unlikely that the rent you could get for the SFH would be 4 times that of the rent you could get for an apartment. Therefore, the "cash flow to cost" of the apartment is much higher than a that of a residential real estate investment.

Aside: For most people who are considering a commercial real estate investment, apartment properties seem to make the most sense. And that's probably because it is the easiest type of commercial property to wrap your head around so to speak. If this sounds like you, then I recommend an inexpensive (under $100) apartment building investment course that will get you started. Here is one I recommend. Even if you choose not to buy it there is a free 10 part mini course that is available called "Getting Started With Apartment Building Investments".

Owner Financing

Your chances of getting the seller to take back financing on a commercial property are much greater than if you were considering a residential real estate investment. This can help reduce the amount of money you will have to come up with, but the flip side of this is that lenders typically demand a lower LTV on commercial properties.

Start Small If You Have To

Remember, your first deal doesn't have to be a 53 unit building. You may be more comfortable starting with a small eight unit apartment complex or perhaps a 4 unit strip mall. Start small and work your way up.

So, Is Commercial Real Estate Investment Right For You?

Ultimately, that's up to you. But don't be shy of moving beyond residential because you are intimidated by the thought of buying a commercial property. With a little bit of knowledge and some focused effort there is no reason that you can't graduate from residential real estate investment into the world of commercial properties.


Return from Residential Real Estate Investment to Apartment Building Real Estate Investment For The Rest Of Us home page