Most people start investing in real estate because they view it as a path to wealth and freedom. What they don't realize is that if they are only investing in single family homes, they are trading in one job for a perceived higher-paying job, but they will not necessarily find the freedom they are looking for.
As we discussed in part one of this article, the people that are making the “big money” in real estate are the ones that own the buildings, not the houses – the people who own the large apartment buildings, the large office buildings, the large warehouses. These are the people who have attained true freedom and are living the lives of their dreams.
There are at least five great reasons why commercial real estate should be a major part of your overall investing strategy. In part one of this article, we talked about the first three reasons. Here's a quick refresher:
First, because it's valued differently than residential properties. The more income your commercial building brings in, the more it is worth. It has very little to do with “market comps”.
Second, commercial properties bring you far greater cash flow than single-family homes. Remember our example of investing $200,000 on a single-family home to make hundreds per month versus investing the same $200,000 on an 8-unit apartment building to make thousands per month?
Third, because in a commercial property, you're spreading out the risk among multiple tenants. You can have several units of an apartment building or office building go vacant and still make positive cash flow.
The fourth reason you should be investing in commercial real estate is because of a concept called “forced appreciation”. Forced appreciation means doing things with your property that will increase your income and decrease your expenses. Remember that the more income your commercial property brings in, the more it is worth.
As an example, let's go back to our 8-unit apartment building. Let's say we plan on improving the quality of each apartment unit by replacing the flooring, upgrading to nicer doorknobs and bathroom fixtures and lighting fixtures, perhaps even adding some ceiling fans – all relatively inexpensive fix-ups. As a result, we can now raise the rents by $50 per month per unit. That's $600 more income per year times 8 units, or $4,800 more per year total (which will also recapture all the costs of the fix-ups).
Next, let's decrease our expenses by $100 per month by passing on a portion of the utilities to the tenants, or by doing some competitive shopping for our lawn-care service and finding a company that does the same great job for less money per month. Times 12 months, we've just saved ourselves $1,200 per year. Total increase in annual income is $6,000 ($4,800 plus $1,200). By increasing our income by $6,000 per year, we've increased the value of the property by $60,000 or more.
That's the power of forced appreciation. There are a lot of strategies that you can use to force appreciation and these are just some of the simplest. But needless to say when you're dealing with 8 units in one building, for instance in our small example, you've got an opportunity to improve many things that will help you justify the increased rents. Also, you'll be seeing yourself dealing with a better tenant mix.
Higher quality properties tend to bring more stable tenants. All of this leads us to the fifth reason why you should be investing in commercial real estate and that is the passive income. Passive income is the key to commercial real estate. The way that commercial properties are managed and the way they allow for a concentration of efforts lets you to put someone in place to manage those properties.
In the beginning, on the smaller 8-unit buildings, you'll probably need to manage them yourself. But as you climb your way up the ladder, and you start dealing with 20-units or above, you can then offer free rent on one of the units to someone in return for managing the rest of the units for you. As we discussed earlier, even with 8 units you can still make a monthly profit if a couple of the units are vacant, so giving away one unit is certainly a small price to pay in return for the freedom it gives you.
Now you've got an on-site building manager who handles all of the tenant problems, tenant issues, tenant improvements, cleaning, and trash removal – all in return for free rent in your two bedroom, $550-per-month unit. Usually these people have other jobs, so you're not their sole source of income. If your buildings are large enough to keep them busy full-time, however, you will probably have to pay them an hourly wage in addition to the free rent, but that will only be a small portion of your total monthly profits.
Meanwhile, all the checks come directly to you. You deposit them, you pay the bills, you keep the difference – and believe me, that difference can be substantial. Even on the small 8-unit buildings that we've talked about, it's easy to generate $2,000 to $3,000 dollars per month in positive cash flow, over and above your expenses. On larger, 20+ unit buildings, it's not difficult to create positive cash flows in excess of $5,000 to $10,000 per month if these properties are acquired properly. And since someone else is managing the properties for you, all this money flows to you passively, while you are spending time with your family, or traveling, or looking for exciting, new opportunities.
Obviously there are many more great reasons to invest in commercial real estate than these five that I've given you – in fact, I could easily list another thirty: cost recovery, how it's financed, management opportunities, scales of economy, and so on.
So, How Do You Get Started?
Just as you would get started investing in residential real estate by getting your education first (either “the easy way”, through books and courses and investor group meetings, or “the hard way”, through the school of hard knocks), the place to get started with commercial real estate is by getting your education and learning the terminology. It's not that different from residential real estate, and it's not that difficult to understand.
Next, look around – see what's going on in your market place. Find several small apartment buildings for sale, get the financial information on them, and learn how they work – what they rent for, how full they are, how the utilities are split up, what the expenses are, and so on. Start doing some “practice” deals – go through the motions of buying the property with as much diligence as you would if you were buying a single-family home. Once you understand what the income is and what the expenses are, you can start to figure out how you would acquire that property.
The sooner you get this process going, the sooner I guarantee that you will be an apartment owner. Don't wait to get started – now is the time! This is the best commercial market in the last 50 years. Properties are available extremely inexpensively, and there are many distressed properties just waiting to be picked up with millions of dollars in equity in all of them. The bank rates right now for commercial property are extremely low. These factors combine to offer you an incredible opportunity. Do not let this market place pass you by, or you may very well regret it.
Can you imagine buying five 8-unit apartment buildings in the next 12 to 24 months? At the end of that time, you'd have 40 units, managed by someone else, and generating six figures of annual passive income. The exciting part is that apartment buildings are just the tip of the iceberg, and in my opinion, not even my favorite investments. I personally prefer office and retail space which have a much higher profit potential. Apartment buildings are nice but office space and retail space generate the really big money. I can promise you that if you start following these simple strategies, you'll generate more than enough gold to fill up the pots for yourself as well as your family and loved ones. The sooner you get started, the sooner you'll see your first $1 Million check!