Many real estate investors leave commercial real estate opportunities aside. The sheer thought of empty office buildings and old warehouses with faded ‘For Sale’ signs on dark and deserted industry parks is often more than enough to scare them off. Commercial real estate investment is often perceived as too risky due to the hardships in securing and keeping good tenants for commercial property and because of the difficulty in getting commercial real estate investment opportunities properly financed. Then, what is the reason that I often favor commercial property as an investment vehicle? Where do I believe that commercial real estate investment can stand out from its residential counterpart?
I am excited about commercial real estate above residential opportunities for several reasons which I will share with you in this article. Vacant commercial buildings do not scare me off. I will show how to make commercial real estate investments work in ways that most often do not work with residential real estate opportunities. The perceived drawback of not being able to properly finance commercial real estate investment deals due to bad loan-to-value ratios can be tackled. Getting and keeping good tenants for commercial properties might not be as hard as often perceived.
There are three reasons why I prefer commercial real estate. The first reason is that commercial property is valued in a different way from residential property. The value of residential property is dictated primarily by the market. Not so for the value of commercial real estate as I will soon explain. The second reason is that commercial leases work in your favor in several ways. Finally, with commercial property I am often not bound to the many laws and regulations associated with residential income-producing real estate investments. This is especially true here in Europe where tenants of residential houses are protected in several ways by law.
Commercial property valuation
Commercial property is valued in a different way from the way residential houses are. The buying price of residential houses is for most part dictated by the market. The market also determines the rent you can ask for your residential property. If you as a landlord charge too much, tenants will leave for other similar properties at a cheaper rent. You might find a house at a bargain price, but in general you will have to pay around market prices for your residential property. Since both the rental income from the property and price you have to pay for the house are primarily dominated by the market, the return you can expect to get is determined for a large part by https://sitecommercial.one the market and not easily manipulated and improved. When investing in residential properties, the return on investment (ROI) you make on the investment is measured by taking the rental income you receive from the property and then to divide this income by the purchase price you paid for the property. If, for example, the house was bought for 250.000 euro and the rental income is 15.000 euro per annum, the ROI is 6 percent (15.000 euro/250.000 euro). Commercial property valuation works entirely different. The value of commercial property is less related to the buying price of the property but depends much more on the rental and other incomes it produces. Its value is defined as the rental income divided by the capitalization rate. Defining the capitalization rate, also called cap rate, is outside the scope of this article. The cap rate is a measure of a property’s performance used by most commercial real estate investors. It is perhaps easy to calculate and a good tool to compare the performance of a specific property with similar properties. Data about prevailing cap rates is often readily available for a specific type of property in a given location.
What is important to remember is that also the cap rate is mostly defined by the market, but that the income that can be produced from commercial property is not as stiff as rents received from residential income. This income can many times be increased in several ways. You could, for example, add mobile phone antennas to the rooftop of your building or increase the rental rate by taking some simple measures such as putting in a good alarm system and digital locks. You might be able to charge extra for allowing a large ad or a neon sign with a company name on the wall of your building facing a busy intersection in town or you could dedicate part of the empty lot next to your premises to install more car parking spaces thereby increasing the price per square meters you can ask for the office space. Improvements made to commercial property tend to have a more direct influence on the value of the property whereby in the case of residential property this relationship between improvements and the rent you can ask is rather stiff. With a little creativity you often can increase the income produced from your commercial property thereby increasing directly the value of the property as well. With additional value added to your balance sheet the moment you increase the income stream from your commercial property, you can use this added value to help you close the deal and get it properly financed or at some time refinance and pull the added value out of the property for other purposes.