Commercial Property Investment Strategy

Any rental property under 5 units is considered residential property. 5 units and over are commercial.
Here is the mind blower.
 
Residential properties are valued or appraised by comparison to recent similar sales prices in the area. If three similar homes sold for $300,000 within the last 6 months, then the home would be appraised at $300,000 for mortgage financing purposes.
 
Commercial properties are valued and appraised by a multiple of their nett income ( rents minus expenses)  and  the Capitalization rate (cap rate) of recently sold similar propertys in the area in which the property is located. If the rent roll is $125,000 and the prevalant cap rate is 0.09 then the value of the home for mortgage purposes would be $125,000 divided by .09=$1,388,888. There are obviously other factors in a commercial appraisal but the general idea is as above.

The magic formula here is that by increasing the income or decreasing the operating costs or expenses you automatically increase the appraisable value. It is like turning base metal into gold, the ancient art of alchemy

A great strategy for the real estate investor trying to make money in real estate is to skip residential properties and focus on commercial real estate. This strategy doesn’t mean that the investor is limited to large buildings. The secret is to begin with a relatively small residential multi unit building.

Everyone who is involved in real estate knows that properties with less than five units are residential and that buildings with five units or more are considered commercial.

What we tend to forget is that residential properties are not appraised by the lenders in the same way as commercial and this is where the goldmine turns out to be for the savvy real estate investor.

Example 1.

A real estate investor buys a small residential rental property with less than five units. The appraiser for the bank values it by comparison to recently sold similar buildings within a one mile radius. The bank lends 80% and the investor comes up with the rest.

To increase the value of the property and enable him/her to recoup their 20% deposit in a refinance the real estate investor must increase the value of the property. But because it is a residential property and because the funds the bank is prepared to lend against it are based on comparisons to similar sold properties the only way to have it appraised high enough to recoup the original 20% is to either hold it long enough for its value to be driven up by price inflation or to improve the property itself.

This is not the best strategy for making fast money. To wait for the property to inflate naturally could take years. To improve it costs more money.

Example 2.

A real estate investor buys a five unit building. The appraiser values it by comparing its income and expenses to that of other commercial properties in the area. This method of appraisal basically subtracts the expenses from the rent roll and multiplies by the capitalization rate (cap rate) that is prevalent in the area where the property is located.

To increase the value of the property and recoup the initial deposit in a refinance the investor merely needs to increase the rent roll and or decrease expenses. Neither of which costs a lot money and if acted on efficiently won’t take a very long time.

By recouping the deposit money in less than a year the investor is funded to look at purchasing a new property and repeating the raise rent lower expenses strategy. This will make the real estate investor very wealthy in a short period of years.

The secret is to look for properties with artificially low rent rolls. Sometimes a landlord who has owner a property for a long time will have neglected to raise the rents and here you will find gold.

If comparable units are renting for say 1000 a month and the property in question is renting its units for 800 a month merely by increasing the rents to market value you have hit a home run.

So to recap: all the real estate investor needs to do to quickly amass a large inventory of rental units is to focus on small commercial rental units. Remember anything with 5 or more units is considered commercial. After closing do what is necessary to raise the NOI (Nett Operating Income- rents less expenses) and refinance to get back the original deposit. Then do a rinse and repeat.