One of the best ways to add value to any investment portfolio is to include a real estate component. However, most investors don’t understand this type of strategy and this fear prevents them from acting upon this sound investment opportunity. It doesn’t matter if the portfolio is based upon making money in the short term or long term, including a real estate property can be the ideal addition.
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Investing In Commercial Property
Perhaps the most ideal type of real estate is the commercial variety. Tenants keep cash flow going through either monthly or quarterly payments, making it easy to realize short terms gains. Once the asset is sold off, then long term capitals gains can be realized. The question in most investors mind is how commercial real estate differs from the more common residential type. The simple answer is that they aren’t different at all. What actually separates the two is the definition of the terms.
Residential Short And Long Term Gains
In order to clarify the two, the types of gains should be examined. When qualifying for a residential loan, the borrower’s credit rating along with the area comparables are the qualification factors. Thus interest rates are inversely proportional to the credit rating of the borrower. And the loan is also repaid by the borrower. The borrower is also responsible to make sure that mortgage payments are made even if there are no renters at that time. These amounts are determined primarily by the value of similar properties in the same area.
Commercial Property Loans
With a commercial property, it is actually the asset that makes the loan possible and also repays it. This is based upon a formula called net operating income (NOI) that is equal to the value of the property. It is calculated upon the income after all of the operating expenses have been deducted, but before the interest and taxes are taken off. So if there is a vacancy in the property, operating expenses are included in the property assets. This also means that qualifying and repaying a commercial loan is based primarily upon the NOI. So the loan is qualified for and repaid by the asset itself.
Commercial Property Appreciation
There are also long term gains to be examined. With a residential property, the value is calculated by the surrounding properties, so capital gains are market driven for the most part and will not be heavily influenced by any upgrades the owner has made to the asset. This has been a factor in the declining real estate values in the residential home market. With a commercial property, this is not true. Forced appreciation is entirely possible here since the valuation is based for the most part on the NOI. While commercial real estate is still influenced by the comparables of the surrounding area, it is also measured by the capitalization rate which is simply the difference between the NOI and its value. So a property that generates more revenue will be worth more money. Therefore, any improvements made by the owner of a commercial property can help to influence the amount of revenue that is generated and consequently increase the appreciation. With a residential property, this is just not possible. This is true because a residential property is compared to the buildings in the immediate vicinity.
Summary
A commercial real estate investment can be a great addition to any portfolio. Short and long terms gains can be garnered in this manner and they are more secure than a residential investment. In addition appreciation can be forced through improvements to the property, making this a smart investment.
