Question:

I have about $500K to invest, and I’m not sure whether I should buy residential or commercial property. What are the differences in appreciation, risk, responsibility or income?

Answer:

I would respond by asking a few questions: What are your goals, is it appreciation, owner involvement or income?

As you might expect, residential and commercial properties have their strengths and weaknesses. Anytime you evaluate real estate, we should first start by qualifying that we only evaluate the ‘right’ residential or the ‘right’ commercial properties because the wrong investment is at best a disaster.

Let’s look at the major differences, in residential we typically have month to month tenants where commercial leases are written in multiple years. Most residential repairs are paid by the owner, whereas in commercial they are tenant paid. In residential apartments, we typically turn over (one tenant moves out, and another moves in) tenants every 13-18 months, in commercial it’s every three to ten years. The law favors the tenant in residential, whereas it favors the landlord in commercial.

My experience is that every time I turn over a residential tenant, I lose six to eight weeks of rent while we make the necessary repairs and advertise the vacant apartment. It costs $1,500 to $3,000 for painting, repairs and flooring to get an apartment ready. The good news is that it’s only vacant a few months. The bad news is that you lose two months income and spend the equivalent of two and half months rent getting it ready. This adds up to a net loss of four to five months of rental income every time you turn an apartment.In commercial, you only turn over the tenant every three to ten years but it could take six to eight months to re-lease the space. The best way I’ve found to mitigate these timelines is to start a dialog with the tenant 6 months before the end of their lease, and if they don’t assure me of a new lease, we begin marketing the property immediately. Often you can have a new tenant under contract before the first tenant moves out. This doesn’t work every time, but when it does; it sure makes for a nice transition.

So let’s get back to your goals. If your goal is appreciation, research will need to take place in order to determine the current market value, the price you will be paying and then a conservative approach to potential increases in value. This analysis would be similar in either residential or commercial. If your plan is to sell the property at some given time, the cost of sale should be factored into the equation.

If your goal is lower risk, then your best bet is probably residential since it’s easier to re-rent the property. If your goal is minimal landlord involvement, then the nod goes to commercial since the tenant is responsible for everything. You won’t have to worry about getting calls on a Sunday night for plugged toilets, or broken glass because in commercial the tenant is responsible for most repairs.

One thing to keep in mind is whether or not you will need a loan for all or part of this purchase. Banks are reluctant to make loans on commercial investment properties so you may need a larger down payment and the interest rates will be higher.

Lastly income, the main reason we invest. From what I have seen when evaluating all aspects of a given property, potential rents, management expenses, utilities, insurance, current repair needs, future repairs, vacancies etc, you will earn a greater income from the right commercial properties over their residential counterparts. My favorite investments are called “mail box investments”. Mail box investments are when the tenant is responsible for all the maintenance and expenses and all I have to do is pick up my rent check from the mail box.

I’m sure that many of you have heard horror stories of real estate investments that have gone bad. One of the best aspects about real estate investments are that even if it sit’s empty, or get’s damaged by a tenant, you still own real estate. It can’t completely disappear like other investments.

I often tell clients, “everybody buys Real Estate, some of us buy Real Estate for ourselves, and those who rent are simply buying it for someone else.”

 

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