by Annette Cooper
Following are a few reasons you may want to consider commercial real estate for your next investment and some of the advantages and risks associated with them. One tremendous advantage that you receive from investing in commercial real estate is the ability to leverage your money. With a percentage of the total purchase price (usually about 25%-40%) you can expand your range of appreciation potential on the purchase price (not just your cash down payment). Unlike the stock market or residential property; with commercial real estate, you can take advantage of the tax benefits of a depreciation schedule and all the tax write-offs.
In addition to receiving the income stream from your commercial real estate, you have the additional potential to participate in the real estate appreciation as well. With a commercial real estate investment you are eligible to take advantage of the 1031 Exchange program. This gives you the potential to build up equity and receive the tax advantages of your depreciation schedule while continuing to let your equity build over time without the interruption of “tax bites” out of your principle. What’s the catch? Let’s explore some of the different types of income property currently available.Here, I’m going to highlight three different categories of commercial property and present the basic advantages and disadvantages. Every one of these categories has a proven formula for success.
THE THREE CATEGORIES INCLUDE:
1. Multifamily Residential Real Estate/Apartment Buildings:
One of the most desirable advantages of buying an apartment building is being able to take advantage of the best financing available in commercial real estate.
Lenders view apartment buildings very favorably. They are considered low risk because there is little chance for a drastic reduction in income, as all tenants will probably not move at the same time. Apartments are probably the most sought after of all investments because most people inherently understand residential income property (everyone has to have somewhere to live). However, it is almost impossible to find a decent return on a Northern California apartment project. With sparse inventory and high demand, some Investors are willing to sacrifice income to speculate on future appreciation. Local municipalities contribute to this strategy with expensive, cumbersome regulations that make new construction difficult and time consuming; thus creating an artificial value to EXISTING residential income property.
The downside to apartment/multifamily investments are the labor intensive issues you must deal with. There are lots of tenants and often you can be beset with an
ongoing list of repairs and replacements which will significantly interfere with your intended “cashflow expectations”. It’s great to purchase enough units to be able to absorb the expense of a manager who will handle all the day to day problems and annoyances as they occur. Typically, there is usually a strong pool of people who welcome this position in trade for a free apartment unit or one with reduced rent. Retirement communities often have a number of couples that covet this kind of opportunity.
2. NNN Leased Investments:
This typically will be a leased investment that is developed by a substantial corporate client who will find the property, build the building and turn around and market it to the investment community at a certain return on their investment. They are able to construct a scenario that gives them the ability to just about pay for their new location even before they open. Depending on the financial strength of the organization, the return on one of these NNN LEASED INVESTMENTS is somewhere between 7-9%.
Some of the more well-known companies using this formula include Chevron gas stations, Walgreen’s, Kragen Auto-Parts, CVC Pharmacies and lots of fast food and restaurant concepts (Denny’s, Taco Bell, Applebee’s, Burger King, TGIF Friday’s are a few that come to mind). The plus side of this type of investment is an absolute no worry investment, (known affectionately as “coupon clipper”.) The company assumes all responsibility for the maintenance and repairs or they take care of everything with the exception of the sidewalls and the roof (some will even take care of absolutely everything including the roof and walls). Typically, you receive a check like clockwork from the parent company. The downside to this investment vehicle is the risk that the company could go bankrupt, that the location could one day become obsolete, or that the tenant may vacate one day and you will be faced with the task of selling or re- leasing the property (which could be expensive and time consuming). However, these sites are hand selected to have high visibility, a strong surrounding demographic base and will probably be a desirable location to other retailers seeking a high visibility and convenient site.
3. Mini-storage facilities:
These can be extremely hard to find as these cash cows have a very loyal following of investors. Mini-storages offer the investor extremely low-maintenance requirements for personnel, have a multi-demographic customer base and give an investor a superior return on the investment dollar.
The downside is increased competition. Developers are always looking for new sites and increased competition can create market saturation that can eventually impact the occupancy rate. Keep in mind that many cities have an aversion to these bland structures and can be extremely hesitant in allowing more to be built.
Copyright: Annette Cooper