“We shape our buildings: thereafter they shape us.” – Winston Churchill
If you know anything about real estate, you know that residential sellers are in big trouble. Some homeowners are getting downright desperate to unload their properties. And instead of wanting to buy more, most investors are looking to unload rental properties that are bleeding red ink every month.
You might be wondering just how the residential market got into this situation.
A few years ago, when the stock market was going down and mortgage rates were cheap, people started buying more property. Which was a good idea. But, as a result, real estate prices jumped up and people believed they would continue to do so. Now that was a bad idea.
Buyers grew accustomed to assuming that you could buy a property pre-construction and it would automatically be worth 30 percent more upon completion. It never occurred to them that if the profits were so sure, builders would only sell the completed houses.
It got to the point where just about everyone you’d run into would tell you they were quitting their job to become a realtor – a sure sign that a market top was imminent. It was a bubble built on emotion. And when it burst, lots of people got hurt.
The same thing did NOT happen with commercial real estate. Sure, commercial property increased along with residential property. But it didn’t go up quite as much and nowhere near as wildly. And it’s not dropping.
Here’s the thing. An investment property is not valued on how nice the kitchen is, if it’s in a good school district, or any other touchy-feely stuff like that. An investor wants to know one thing: “How much money will I make from this?” That’s all. If it will cost him more in financing and expenses than he will get in rent, he won’t buy it. Simple as that.
That’s the thing with income property. You know how much you’ll make from a property before you buy it. And it moves in different cycles than residential real estate.
Why Commercial Real Estate Is a Great Investment – Even When Residential Isn’t
The value of a commercial property is generally based on the amount of income it brings in. If the income doesn’t rise, the price of the property doesn’t go up much. The flip side is also true. If the income doesn’t fall, the value of the property usually doesn’t fall much either.
Why? The seller knows you’re only going to buy the property as an investment, not because it’s pretty or near your friend’s house. It has to be a deal, or you won’t be interested. They tell you right up front how much the property makes in gross rent (total cash coming in) and NOI (net operating income – the profit you’re left with after expenses).
Essentially, buying a commercial property is buying an income stream. So it makes sense that the gyrations of the residential market have little effect on it.
Right now, for instance, Miami apartment condos are in a major slump – along with the rest of the South Florida housing market. But booming international trade has made for a healthy warehouse market in Miami, including a booming market for condo warehouses. Similarly, office, industrial, and retail space are strong in many of the same parts of the country that are suffering major slowdowns in the housing market.
Seek and Ye Shall Find
Commercial properties are listed on the Board of Realtors’ Multiple Listing Service (MLS), but you’ll find a much wider selection and more extensive information on websites that are dedicated to commercial property. Two of the biggest are Re3w.com and Loopnet.com.
Both sites have listings in all commercial categories, including apartments, from all over the country. Loopnet.com has many listings that can be viewed for free, with perhaps 20 percent or so reserved for paid subscribers. Re3w.com is a paid service that can add value to Loopnet’s free searches, and it offers a 30-day trial. Browse this site to begin to familiarize yourself with commercial properties. You can look for properties in your hometown or in your favorite growth market.
You’ll see a few ratios mentioned. Don’t let them throw you off. They’re not that complicated. You’ll also find “net income” mentioned a lot. That’s the cash the property produces after expenses but before income taxes or debt service.
The most commonly mentioned term is “cap rate,” short for capitalization rate. That’s simply the net income divided by the purchase price. All other things being equal, the higher the cap rate, the better. However, all other things are usually not equal. So cap rates depend on the type of the property and its condition.
A high-end apartment complex being sold as a condo conversion might be offered at a 5 percent cap, while a small complex in a working-class neighborhood might go for a 12 percent cap. A well-maintained retirement mobile-home park might go for a 7 percent cap, while a low-income mobile-home park could go for a 20 percent cap.
If you could put up with the aggravation of running it, or know someone capable of managing it for you, the low-income property could be a good deal. If not, you’d want to set your sights on a nicer property, even though it would not be as profitable.
The best way to get comfortable with these and other key commercial real estate ideas is to surf commercial sites and look at the offerings. Do this at least as often as you surf for residential properties… and you may find yourself quickly transitioning into a real estate baron of the commercial kind.[Ed. Note: Toby Unwin is an active commercial real estate investor and author of the best-selling ETR Real Estate home study course “One Deal From Retirement.” In a reservations-only teleseminar this Wednesday, August 22, Toby will reveal how a single commercial property deal can provide you with enough equity and cash flow to retire permanently from the 9 to 5 grind.]