Real Estate in and of itself is a broad scope of different investments. When discussing real estate it can be mind blowing due to all the differing opinions and sectors involved. In this article we will discuss the two most common sectors of real estate, which is Commercial and Residential. Whatever your main goal is in the industry be sure to sharpen up on all the different avenues.
Differences in Commercial & Residential Real Estate
Commercial Real Estate
As we said before the difference in residential and commercial is that commercial real estate is driven by its cash flow.. Commercial Real Estate will require a higher down payment because commonly most banks will only lend 70-80% of the total value of the building. What this means is the cash on cash ROI will be lower. On the other hand though, Commercial Real Estate has near infinite scalability.
For example if you purchase a commercial property in the year 2000 for 1 million dollars, you would pay a down payment of $250,000 and would have a yearly rent of $110,000, adding in $75,000 of yearly expenses. The NOI (Net Operating Income) is $35,000. This equals out to cash on cash ROI of 14%. This is assuming the annual growth rate stays at 3.7%, the building itself would be worth $1,740,000 in the year 2020. If you add all of that together the net income plus the appreciation of the asset itself gives you $2,190,000 as the investor, This is a 12% compounded return and total return of 736%.
When you look at the ROI of commercial real estate you will notice that this is lower because of the down payment being higher. With that being said the ROI holds true as the value of the property continues to increase over time. With a $10 Million dollar asset, as the investor you can expect to have similar returns. If you planned to get a return of $10 million you would have to then invest in 100 houses.
Another thing to be considered is the intentions and the length of lease your tenant(s) will sign. This will help you determine if you should invest in commercial real estate in the first place. When you are dealing in residential properties we normally consider a 12-24 month lease a long one, and the landlord is responsible for any and all maintenance up to an agreed upon amount. With commercial real estate you want a lease that is longer such as a 5-10 year lease. Another plus is with commercial properties most of the time the tenant is responsible for the repairs the building may need. This means that commercials are closer to passive income than residential.
Residential Real Estate
Location, Location, Location! This will determine the value and entire appeal of your investment. The first thing consumers look for is where is the property located, and will it fit their individual needs? Commercial real estate is mainly focused on cash flow on the other hand. Residential will require less capital from the investor, and therefore this is the best place to get started. Normally. 10% of the purchase price is required for a down payment and typically the rest of the money is borrowed.
For example, if you are buying a property costing $100,000 that would require you to pay $10,000 as your down payment, the $90,000 left on the loan can be borrowed as a mortgage. Always keep in mind that you have to also factor in closing costs and fees, round higher to get a better feel for what the total investment is going to be.
Renting can be a costly business. Normally annual rent is around $12,000 and factoring in the expenses, including mortgage payment and the capital expenditures, are in the $10,000 range. That will leave you with a net operating cost of $2,000, which equals a cash on cash ROI of 20%/ The real rate of return will be higher due to the principal amount being paid down.
In the past, real estate has gone up in value by 3.7%. This may strike you as not much of an increase. But keep in mind that the purchase was made using leverage. Considering that only 10% of the purchase was required up front that leads us to a 37% return on the capital outlay.
If you purchased a home costing $100,000 in the year 2000 and it then grew in value at a yearly rate of 3.7 % all while it is generating a net operating income of $2,000 annually. At this point the value of the house is at $174,000 and your profit from renting the property is round $40,000 in the year. What this means is the ten grand down payment yielded a return to you of $204,000. That is a 16.5 % annual compounding return and a total return of 1,904%
Casey Development, Ltd: San Antonio, Texas Commercial Real Estate Developers
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