Real Estate Investing: Commercial or Residential?
Did you know that 46 of the world’s billionaires made their fortunes in commercial real estate investing? Just look at Donald Trump, Robert Kiyosaki (author of Rich Dad Poor Dad), and the Kennedy family. Their real estate investing produces huge cash flows, also called “passive income” by buying and holding real estate. Then there is Red Auerbach of the Boston Celtics. He made his real money buying apartment buildings, then branching off into hotels. Likewise, Arnold Schwarzenegger made his first fortune buying apartment houses in Colorado.
Here are some of the reasons commercial real estate investing is better than residential:
1. The government takes 33-50% of your profits if you buy and sell homes! When you hold houses for less than a year, your profits are taxed at the painfully high rate of “ordinary income”. With commercial real estate you’ll pay the low capital gains rate (now 15%).
2. When you’re flipping or investing in houses you’ve got to keep working to earn your next “paycheck” through marketing, buying, renovating, and selling or we have to do it on your behalf. And if you don’t want the contractors to screw up, we have to supervise them constantly. Wouldn’t you rather make passive income month after month…and reap positive cash flows from real estate investing– with less risk, less money down, and no tenant headaches?
3. Most bargain homes are in disrepair. You’re at the mercy of contractors. You’ve got to renovate the properties. But most contractors are unreliable. We oversee everything they do, or risk paying for their mistakes. And the good contractors are always booked up for months in advance.You lose money for four to six months. That’s how long it takes to fix up a house and resell it. When the contractors drag their feet, you’re left helpless and stressed out. Every day your house sits vacant, your bank account is further depleted by loan payments, taxes, insurance, utilities and time.
When you finally sell, you’ve got to start all over again, marketing, negotiating, and overseeing the contractors. If you take time off, or can’t work for awhile, you have no income. That’s not financial freedom.
When you invest with us in the commercial properties we find for you our carefully chosen property managers will handle 100% of the tenant management. They charge an average of just 6% of the gross rents (versus 10% for single family homes). This lower percentage, combined with your monthly income, makes it easy to afford a property manager. You will never deal with tenant complaints, repairs, or vacancies.
And you will use a legal tax loophole to pay zero taxes when we sell the properties for you. All you have to do is roll your sales proceeds into a bigger building (with even better cash flow). You could start profiting instantly. Rather than being drained for 4-6 months, carrying the costs of a vacant house, you can enjoy positive cash flows from day one.
When your single family home is vacant, the burden of paying the mortgage, taxes, and insurance falls entirely on you. But if your apartment building has a vacancy, the other tenants cover your expenses. Unlike the average home seller, investors are used to buying on terms. So the seller is much more willing to help you finance your purchase.
In fast growing markets, apartment buildings appreciate faster than houses. Why? When people relocate, they rent before buying. And multi-family properties are valued based on their rents. And history shows that rents always climb along with interest rates.
If you want to collect an automatic monthly income, you need properties with big positive cash flows. But without our checklist, you could overpay, make too many concessions, or lose the property to a competing buyer. We will find you nine ways to slash your costs, increase your income, and increase the resale value of the multi-family building. We will reduce tenant turnover, challenge tax assessments and slash the utility bills. We will raise rents and do renovations which will dramatically boost the building’s resale value.
You, the investor, can partner with us (i.e. you put up the money, we do the work, and we split the profits 50/50).
As the properties appreciate and the tenants pay down the loan balances equities will amass. Raising rents will further multiply the value of the buildings. So sooner or later, you may decide to “cash out”. It won’t cost you an additional 20% of your profits or more. You can legally defer those capital gains taxes forever – using 1031 exchanges. You will roll your gain from each sale into bigger apartment buildings (with bigger cash flows) – and never pay taxes.
We have a Commercial Deal Analyzer. We can determine average yields for an area, compare properties, and will move fast when we find a hot deal – before the seller gets another offer. We fill in the blanks to calculate the projected cash flow, net operating income, and cash-on-cash return.
The next step would be for you to tell us exactly what you are looking for. To do that please fill out the form here:
We will then start to look for properties that fit your criteria.
Explanation of Commercial Real Estate Terms
These terms are important for you to understand as they are the ones most commonly used by the professionals with whom you will be working. This is not intended to be a glossary, but an explanation of the terms through an example.
Net Operating Income (NOI)
The Net Operating Income (NOI) of a property is calculated by determining the
property’s first year Gross Operating Income and then subtracting the Operating
Expenses for the first year.
Gross Operating Income
Less
Operating Expenses
Equals
Net Operating Income
The Gross Operating Income of property is the total income a property can expect
to receive from all sources over a one year period. The Operating Expenses are
the expenditures needed to keep the property operating during the same period.
(See the article Cash Flow Model for a more thorough explanation.
Sample Calculation:
$500,000 Gross Operating Income
Less
$300,000 Operating Expenses
Equals
$200,000 Net Operating Income
The NOI of a property comes directly from the operations of a property and
disregards mortgage payments or other additional expenditures the property owner
may make, such as tenant improvements or leasing commissions.
Capitalization Rate (Cap Rate)
Many investors start their financial analysis of a property by calculating the
NOI in order to be able to calculate a Capitalization Rate (Cap Rate) according
to the following formula:
Net Operating Income
Divided By
Property Price
Equals
Cap Rate
The Cap Rate is expressed as a percentage rate. Cap Rate is typically calculated
based on the first year of operations of the property and an all cash purchase
of the property.
Sample Calculation:
$200,000 Net Operating Income
Divided By
$2,000,000 Property Price
Equals
10% The initial annual un-leveraged return on an acquisition (also known as the capitalization rate or net initial yield).A cap rate measures the ratio between the net operating income produced by a property and its capital cost (the original price paid to buy the asset).
For example, a property’s capitalization rate is ten percent if it is purchased for $10 million and produces $1 million in net operating income during one year.
A Cap Rate can be looked at as a first year return to the investor comparing how
much the investor would receive from operations with the price that would be
paid in an all cash purchase of the property. It is a measure of performance the
investor can look at to compare how their money is working for them in one
property compared to another property or investment.
Many institutional investors purchase their properties for all cash, not using
any financing. For them, the Cap Rate is a valuable method of comparing
properties. Individual investors often use financing and it may be more
appropriate for them to use additional methods of comparing first year returns.
Cash On Cash
Many investors who use financing to acquire properties use the Cash on Cash
method to compare first year performance of competing properties. Cash on Cash
takes into consideration the fact that the investor does not have to have all
cash to purchase the property, but also will not keep all of the NOI because
they must make their mortgage payments from their NOI.
First, the investor must determine the amount they must invest to purchase the
property or their Initial Investment.
Total Purchase Price Plus Costs
Less
Amount Financed
Equals
Initial Investment
Sample Calculation:
$2,050,000 Price + Costs
Less
$1,550,000 Loan
Equals
$500,000 Initial Investment
Next, the investor must determine the first year Cash Flow from operations,
including the payments due on the financing.
Net Operating Income
Less
Payments on Financing
Equals
Cash Flow
Sample Calculation:
$200,000 Net Operating Income
Less
$140,000 Payments
Equals
$60,000 Cash Flow
With the calculation of the Cash Flow and the Initial Investment, the investor
can make another comparison of how their money performs in this property
compared to other properties. By calculating Cash on Cash the investor can
calculate a first year percentage return on their investment in the property.
Cash Flow
Divided By
Initial Investment
Equals
Cash on Cash
Sample Calculation:
$60,000 Cash Flow
Divided by
$500,000 Initial Investment
Equals
12% Cash on Cash
The Cash on Cash percentage can be looked at as a first year return to the
investor comparing how much the investor would receive in cash flow from the
property when the property is purchased using financing. It is a measure of
performance the investor can look at to compare how their money is working for
them in one property compared to another property or investment, when financing
is used.
Many investors use the Cash on Cash percentage in their investment decisions as
more accurately reflects their results than does the Cap Rate which ignores the
financing used to purchase the property and the payments that must be made on
that financing from the NOI of the property.