Investing in real estate is one of the best ways to earn a somewhat passive income, after all, people will always need a place to live, and if you are the provider of that solution, you will make money.
Now, there are several ways to invest, as not all real estate is created equal: you can buy single-family homes, condos, warehouses, commercial properties, storage, and multifamily properties.
However, even on multifamily properties, we can find different concepts when it’s time for you to invest. So, stay tuned to this video to understand the differences between a Residential and a Commercial Multifamily Property.
If you follow me for some time you know how multifamily properties are my preferred method to invest in real estate. I, myself, already developed a 20 unit multifamily project with my investors from Brazil.
This kind of property provides several benefits for investors:
Lower vacancy risk
Economy of scale
Better negotiation power
Protection over recession
Easier to leverage
Using depreciation to reduce your taxes
All those benefits you will find in both Residential and Commercial Multifamily properties, but there is one that you can only find on the Commercial properties.
Before talking about that, let’s define what is Residential and what is Commercial Multifamily.
In Florida’s real estate law, a property with up to 4 units is considered residential. When we say 4 units, they must be under the same roof, or within the same folio.
For instance, a duplex, a triplex, and a 4-plex are buildings with 2, 3, or 4 units under the same roof. You can have them on a single floor, or on multiple floors, but the common ground here is that they are under the same roof and the same folio.
However, you can also have bungalows, which are small houses. If under one folio, you can build as per your local building code, 2 or more units, you can also call that residential multifamily property.
The folios with 5 or more units are called commercial multifamily.
Ok, and why knowing this is important for investors?
That can unfold in different aspects. For example, in some cities, you cannot do short-term rentals in residential properties, but you can in commercial properties. So if you are looking to invest in Airbnb kinda thing, you must buy commercial multifamily.
Another great difference between those kinds of real estate is that because properties up to 4 units are residential, you can use the same lines of credit to purchase it as you would for your house, including programs guaranteed by the government, such as FHA and VA loans.
And the 3rd, and for me, the most important is the ability to control the value of your property.
When you are buying a residential property, and you need finance, the bank will call an appraiser to identify the market value of that asset. To make a long story short, an appraiser will assess a value to your property based on the comparable, similar properties that were sold recently, of that market.
On the commercial side, they also use a comparable analysis, however, instead of comparing to the property value, they compare to the property Cap Rate, or return on the investment it generates.
That’s important because on the residential multifamily, regardless of your cost efficiency or how much you can make, when it’s time to sell, it will be compared to other similar properties, reducing your power to control the value.
In the commercial, in another hand, because its value is based on the return, the better your revenue is and the lower your costs are, the more your property is going to be worth. Here’s an example:
In a given market where the average cap rate is 5%, a property that generates $100,000.00 of Net Operating Income per year is worthed $2,000,000.00.
However, if because of lack of management, the same property only generates $80,000.00, its market value now is $1.6 million.
Regardless of residential or commercial, I find multifamily properties the best way to invest in real estate.
If you have several single-family homes, consider selling them all and buying a multifamily property. And, if you do, watch my video next week about how to not pay taxes on your capital gains.