How Much Money Do You Need to Invest in Real Estate?

With the increasing inflation rate and the declining value of the dollar, many individuals are considering real estate as a valuable addition to their investment portfolios. Despite the steady increase in property prices in recent years, investing in real estate remains affordable. In this article, we will explore the differences between residential and commercial real estate investing and discuss the amount of money necessary to invest in this lucrative market.

Residential Real Estate Investing

When people consider real estate investing, the first thing that often comes to mind is buying a residential rental property. This is understandable as residential properties are ubiquitous and easy to finance. According to Zillow, the typical home value in the U.S. is around $280,000. With a conventional loan requiring a 5% down payment, you would only need $14,000 to purchase a home.

Investors looking for turnkey rental properties already leased to tenants can find houses priced under $100,000 on platforms like Roofstock and Norada Real Estate Investments. While most residential real estate investors hold properties for the long term, others are willing to take on more risk by flipping houses for quick profits.

However, it’s important to note that residential rental property may not always be the ideal choice for every real estate investor.

Limitations of Investing in Residential Real Estate

Due to the popularity of homes as an investment option, there is significant competition from both individual and institutional investors. Additionally, being a landlord is not as easy as it may seem, even when you hire a property management company. Most property management firms charge 10% of the gross rental income as a monthly management fee. This means that if a house rents for $1,500 per month, $150 goes directly to the property manager before any operating expenses are paid.

Many residential real estate investors choose to self-manage their properties, which comes with its own set of potential problems. Landlords need to market vacant properties, screen tenants, ensure rent is paid on time, and deal with repairs and maintenance. Moreover, specific state residential landlord-tenant laws must be followed when evicting tenants or dealing with rent-related issues.

Another drawback of residential rental property is that you bear all the risks. You are responsible for annual property tax payments and funding major repairs and replacements, such as a new roof or heating and cooling unit. Additionally, owning property directly exposes you to potential lawsuits, such as when a tenant’s guest gets injured on your property and decides to sue for negligence.

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Furthermore, the cash flow generated by single-family homes can be inconsistent. When a tenant leaves, the vacancy rate is 100% until you can repair any damage and find a new tenant. During this time, you still have operating expenses and mortgage payments to cover. As a result, it can take years before consistent, positive cash flow is achieved.

Residential Real Estate Can Be Costly

Residential rental property is often considered the best way for real estate investors to earn passive income. However, in reality, being a landlord can be quite demanding. Rising inflation has led to increased labor and material costs, which can quickly spiral operating expenses out of control. This can result in negative cash flow, especially since rent increases are typically only possible once the current lease is up for renewal.

In some states, the process of evicting a non-paying tenant can take months and cost between $4,000 and $7,000, depending on the location and duration of the eviction process. Consequently, it may take several years to recover these expenses and start turning a profit again, even if the property usually generates a few hundred dollars of positive cash flow per month.

Commercial Real Estate

Investing in commercial real estate provides a viable alternative to residential real estate due to higher income streams and a wider variety of investment opportunities. In fact, increased profitability and a greater selection of choices are two primary reasons why residential rental property owners eventually transition to commercial real estate.

What is Commercial Real Estate?

Unlike residential property, which is rented to individuals for living purposes, commercial real estate is leased to businesses of all sizes and types. Businesses may purchase their own commercial properties, or developers may invest in raw land to build office buildings, retail spaces, industrial facilities, or mixed-use projects. Commercial lease terms are typically five years or longer, often including rent increases and customized agreements to cater to the needs of both tenants and landlords.

Five Types of Commercial Real Estate

Commercial real estate is generally classified into five main types, each with its own subcategories. These types include:

Retail

Retail properties range in size from small storefronts to power centers and factory outlets. Tenants in retail developments typically sell consumer goods and services. Common examples are grocery stores, clothing shops, beauty salons, and insurance agencies. Retail centers often have anchor tenants, such as Whole Foods or Walmart, that attract customer traffic.

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Office

Commercial office buildings include single-tenant properties like doctor’s offices, mid- and high-rise buildings in downtown areas, and large campuses with multiple low-rise office buildings spread across vast areas. Offices are categorized into different classes, such as Class A, B, and C. Class A buildings are new with modern amenities and leased to creditworthy tenants, while Class C offices are older, have outdated designs, and are located in less desirable areas for businesses.

Multifamily

Properties with four or fewer units, like duplexes and triplexes, are considered residential properties. However, buildings with more than four units fall into the category of multifamily commercial real estate. These buildings include garden apartments, low-rise structures, and high-rise apartments typically found in urban areas. Unlike other commercial property types, multifamily leases are usually short-term, typically lasting only 12 months.

Industrial

Industrial properties consist of warehouses, distribution centers, factories, manufacturing plants, cold storage facilities, data centers, and flex buildings that offer a combination of office and industrial space. The key distinction between industrial properties and others is their significant size. Industrial projects like Tesla’s 4 million square foot Giga Texas and Amazon’s 4 million square foot Project Rodeo underscore this point.

Special Purpose

Special purpose properties represent a diverse category offering potentially high profits. Examples include student housing, senior living facilities, car washes, bank buildings, educational and religious buildings, and self-storage properties.

Owner-Occupied Commercial Real Estate

Similar to homeowners buying houses to live in, businesses can also purchase and occupy commercial real estate. When a business occupies 51% or more of a property, it is considered owner-occupied commercial real estate (OOCRE). In certain cases, a business may sell a property it owns to an investor and lease the building back through a process known as a “sale-leaseback.” This arrangement enables businesses to convert equity into cash, while investors can enjoy higher and more predictable rates of return.

Benefits of Commercial Real Estate Investing

Investing in commercial real estate offers several advantages.

Cash Flow

Commercial real estate leases tend to be longer, providing more predictable cash flow compared to residential rental properties. Additionally, lease terms can be tied to the Consumer Price Index (CPI), allowing landlords to adjust rent annually based on changes in inflation. Furthermore, commercial landlords can pass on operating expenses like property taxes and insurance directly to tenants, reducing the investor’s risk.

Higher Income

Because commercial properties are often occupied by multiple tenants, investors benefit from multiple income streams. In contrast, when a tenant leaves a single-family home, the vacancy rate is 100%. Even if five tenants leave a 100-unit self-storage facility simultaneously, the occupancy rate is still 95%. The stability of income in commercial real estate is generally higher, resulting in a greater return on investment compared to residential rental properties.

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Longer Leases

Commercial properties are typically leased to businesses for 5, 10, or even 20 years. Rents can be adjusted annually using CPI increases to match inflation changes. Most commercial leases also follow a net lease structure, where tenants are responsible for property taxes, insurance, and maintenance expenses. These factors contribute to a more secure investment.

Less Competition

While some may perceive commercial real estate as challenging to invest in, it actually presents opportunities for those willing to navigate the complexities. Participating in private equity commercial investment offerings is a popular way to invest in commercial real estate without directly owning and managing properties. Limited competition in the commercial real estate market provides greater potential for earning passive income compared to residential investments.

Limited Operating Hours

Commercial buildings are typically occupied by tenants who maintain regular business hours. This simplifies property management, as landlords are not required to be available 24/7 for emergency repairs or tenant communication at all hours. The limited operating hours of commercial properties contribute to easier management and reduced stress for landlords.

Better Business Relationships

The professional nature of commercial real estate tenants allows for stronger relationships between landlords and tenants. Well-managed properties contribute to the success of tenants’ businesses, fostering a win-win scenario. When tenants thrive, they often expand their presence by leasing more space. Consequently, commercial real estate cultivates better business relationships between landlords and tenants.

How Much Money Do You Need to Invest in Commercial Real Estate?

Contrary to popular belief, investing in commercial real estate requires less capital than most people assume. Compared to purchasing residential properties, commercial real estate investing can be surprisingly affordable. Rather than attempting to purchase and operate a property individually, investors can allocate smaller amounts of capital across multiple commercial real estate investment opportunities. This approach facilitates diversification of investment portfolios and increases the potential for higher returns. For example, investing in the Reliant Real Estate Fund II requires a minimum investment of only $50,000, offering access to the lucrative commercial real estate market.

Conclusion

Investing in commercial real estate requires less money than many individuals imagine. By partnering with experienced investors, individuals can easily incorporate commercial properties into their investment portfolios. Commercial real estate investments offer robust cash flows, tax benefits, higher returns, and protection against inflation. So, if you’re considering real estate investments, don’t overlook the significant opportunities awaiting you in the commercial sector.

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