22 Mar Why Commercial Real Estate Might Make For Better Investments
by James Nelson, head of Avison Young’s New York City-based Tri-State Investment Sales Group
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If you’re thinking of investing in property, you may have found resources on how to fix and flip homes. Books and TV shows often show how to get involved in this space, and certainly if you time it right, you could get a quick return on your investment. The process is typically to buy a home that needs renovation, make changes and updates, and then sell for a marked-up price that covers your expenses and brings in a profit for your work.
While it may be appealing to try buying and fixing up homes, there are other real estate investments that you may want to consider as well. In my book, “The Insider’s Edge to Real Estate Investment,” I focus on commercial real estate investments. In the multifamily segment, I define these as properties with at least five units. There are other types of commercial real estate investments including office, retail, and development.
Given this, before rushing out to buy a single-family home and start renovating it, it could be worthwhile to compare the two types of investments. Once you understand the differences between residential and commercial real estate transactions, you’ll be better equipped to make a decision. You could even spot opportunities that aren’t easy to find, and offer a higher-than-average return.
The Holding Times are Different
If you’re in the business of reselling residential properties, you’re likely making a purchasing decision that’s based on the repositioning and selling of the asset. This will often depend on both the improvements that are made and the market conditions. If everything aligns, you could bring in a profit when you sell. The potential short-term gain will play a significant role as you consider a home to buy.
For commercial investments, the decision doesn’t always focus on the later sale. Instead, it typically hinges on the cash flow. That’s not to say that investors don’t speculate; however, they tend to be more focused on the income that the property can generate. Based on what they find and how the property operates, they might plan to hold the asset for the long-term.
The Competition Varies
When purchasing single-family homes, investors often find themselves competing with end-users, who are other homeowners in the area. This can present a challenge, as the other buyers on the market might not be as concerned about their bottom line. They might be willing to pay a premium to get a certain amenity or move into what they view as their dream home. This means you may have to pay more than planned to get a home you were considering for a fix and flip project.
For commercial properties, investors are usually competing with other businesses and investors. Some may want to see if the place is vacant or not, as that will impact the cash flow. I often advise that it’s better to buy a property that is occupied and brings in a stream of income, as opposed to a place that is vacant and needs a tenant.
The Buying Processes are Distinct
If you’re looking for residential properties, you’ll generally find them through a multiple listing service (MLS) or advertised as “For Sale by Owner.” Finding an off market for a residential property is quite rare, so you’ll be competing with the open market to get a single-family home. This means that usually everyone else has access to the same information as you.
Commercial properties often change hands through off-market deals, where properties are not publicly listed. This creates a more inefficient marketplace and could provide opportunities. You might be able to find a great place where you could add value and have less competition when making a bid for it.
Financing is Not the Same
If you’re buying a residential property that doesn’t generate income, it’s rare today that a lender would offer you a non-recourse loan. In most cases, you can expect to have to personally guarantee the debt. This could add pressure as you fix it up and then sell to pay back the loan. In addition, when you sell, the proceeds could be considered ordinary income and taxed at a higher rate than what you might pay for the sale of a commercial property that has been held for a long time and brings in a long-term gain.
For commercial properties, you could be eligible for a non-recourse loan, meaning you won’t have to personally guarantee it. In addition, you could benefit from other tax strategies later, such as carrying out a 1031 exchange when you sell to invest in other properties.
As you consider residential and commercial properties, it’s true that people always need a roof over their head. As such, you could find more demand in the market than for a commercial property such as a vacant office building. Still, the ultimate decision will depend on your interests and long-term goals. Once you know the market in your area, you can choose a path that makes sense for your situation.