The age old real estate question: Commercial vs. residential real estate investing. What property class is a better investment?
Dig deep and you will find a dichotomy between commercial and residential real estate investments. Financial analysis, zoning, contracts, market data, financing and location are examples of investment real estate fundamentals we rely on, but sometimes forget. Occasionally, you may find a blip in the fundamentals that just doesn’t make sense.
In the news you may have read of an investment group led by a hotel and casino entrepreneur who purchased 6,350 abandoned and dilapidated properties in far-reaching Detroit. The group was the sole bidder at $3,183,500, which equates to just over $500 each.
I am asking myself, “Why would an astute group of investors make an investment of this type that could potentially cost much more in the long run.” Two-thousand properties are overgrown vacant lots, three-thousand have houses needing to be demolished at an estimated cost of $24 million and the remaining are houses in need of major rehab.
The head of the investment group is a former Detroit resident so I am assuming emotions are involved. He may want to leave a legacy as the “saving grace” of Detroit. Three million dollars is a lot of money, but not necessarily in terms of commercial real estate values. A single commercial property in Napa could easily go for this amount.
This brings me to the major differences in commercial and residential investments. How would your investment differ if you were to take three million dollars and purchase one commercial property or six single-family houses in Napa holding for ten years?
- You would had secured potentially one tenant for the commercial building versus thirty for the houses if each tenant stayed two years. This creates significantly more time and effort as well as more maintenance costs in preparing the property for a new tenant.
- However insignificant, depreciation for the houses could be more because the IRS allows for a 27.5 year schedule for residential real estate versus 39 years for commercial.
- Property management efforts of the six houses would be significantly more and includes being called for clogged toilets in the middle of the night. You tend to not have these types of concerns with a commercial property.
- The return on investment over the last ten years on residential real estate is negligible as if you purchased in 2004 you were at the top of the market. Commercial real estate tended to fare better on average, but not much. The question is what the next ten years holds. My guess is commercial real estate trends will continue to show stabilization. But, I am not so sure of the same for single-family residential as I believe we are in another bubble.
There are many other differences to consider such as cash flow, financing, insurance, legal concerns, etc. For the small investor, oftentimes personal preference and market knowledge are the driving forces. For me I have owned both and prefer commercial especially when it comes to pursuing a gamble of 6,350 homes or a sure thing.