Is The Pot At The End Of Your Rainbow Filled With Fool’s Gold?
Why You Need To Start Investing In Commercial Real Estate TODAY…
BY: J. Scott Scheel
People often ask me how I got started in commercial real estate, and I tell them that it was a conscious decision for me.
Most people who begin investing in real estate start off with single family residential properties because that is what they are most comfortable with. They tell themselves, “All I need to do is a couple of deals a month. I’ll make myself five or ten thousand dollars, then at the end of a very few months most of my problems will be taken care of.” They do not really understand everything that is involved in getting these properties going.
They think they are going to be making big money, but before long, oftentimes they end up with a lot of problems and a lot of headaches. They might have traded in their job for a perceived higher paying job, but find that it is really taking a toll on their lives.
If you belong to a real estate investment group, take a look around you. Look at the people who have done twenty-five to fifty houses or more. Are they living the life of their dreams? More importantly, are they living the life of your dreams? They may be better off than you are now, but is this really what you want to work towards?
I know so many people who have a large portfolio of properties but really haven’t achieved the type of freedom, success, and wealth that they truly desire.
How can you change this?
In my opinion, the answer is commercial real estate.
When I decided to start investing in real estate, I stopped and took a look around. I realized that the people who were making the big money in real estate were the people who owned buildings not houses. People who owned the large apartment buildings, the large office buildings, the large warehouse and industrial space – those are the ones who really seemed to be living a lifestyle that I wanted.
They didn’t have to be there tending to their properties; they had property managers who took care of that for them. Yet, they were the ones spending the checks, catching planes to exotic locations and destinations, and living the lifestyle that I desired so much.
After looking at this for quite a while, I decided that there must be a way of getting this done. They couldn’t have been much smarter, have learned much more, or have had access to more resources then I could. Even though I didn’t know how immediately, I knew I could figure out a way to do it.
I sat down and took the time to learn how to invest in commercial real estate, which is what I would recommend that you do. I studied and figured out exactly what it would take, and as I learned, commercial real estate became less and less of a mystery to me.
How can you start? First of all, let’s talk about why you would want to do it.
What are the benefits of commercial real estate? First of all, one of the biggest benefits is that commercial real estate is valued differently. By “valued differently”, I mean the amount of income that a property produces is directly proportionate to its worth. So if a property produces more income, then it is worth more. It has very little to do with “market comps”.
Second, along the way you are going to get a far greater cash flow. Imagine if you were to buy a $200,000 home. That $200,000 home may rent for somewhere in the neighborhood of $1,500 per month. The underlying mortgage on that home may be somewhere between $1,000 and $1,400 per month. So you end up struggling to gain between $100 and $500 per month in positive cash flow. That’s not a very high number for the amount of work you have to put in, and it certainly is not going to get you on the jet set.
Now, let’s take a look at a similar investment from a commercial standpoint. That same $200,000 investment may end up yielding you an 8-unit apartment complex, based on $25,000 per unit to acquire the property.
Let’s say each of those units were two bedrooms, which could rent in most areas of the United States anywhere between $400 and $600 per month. For simplicity’s sake, let’s use an average of $500 per month. At $500 per month times eight units, you’re bringing in $4,000 per month – more than double the rent that you could expect to get from that same $200,000 single family home. Your underlying mortgage payment would be very similar to what you would expect on a residential property; for this example, let’s use $1,400 per month.
Your cash flow on this 8-unit apartment building will be $2,600 per month ($4,000 per month income, minus $1,400 mortgage payment). Now that will make a difference in just about anyone’s life.
Third, and most essentially, you’re now spreading out the risk over eight tenants, as opposed to one. If your single-family home goes vacant, you’re on the hook for the entire mortgage. Every penny of that mortgage, all of the maintenance, and everything that goes along with it is now your responsibility. If the house is vacant for two months, you’d better be planning on spending a minimum of $2,800 to cover that mortgage plus miscellaneous expenses including maintenance, utilities, taxes, and insurance. Potentially, you’re looking at a very heavy negative cash flow.
On the commercial property, however, if one of your eight units goes vacant at $500 per unit, you’re still bringing in $3,500. So you get slightly less positive cash flow but you’re certainly not experiencing negative cash flow. Say three units go vacant – you’re still covering your mortgage and experiencing 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!
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