“You miss 100 percent of the shots you never take, and if you think it’s expensive to hire a professional to do the job, wait until you hire an amateur “
WRITTEN BY Ian Formigle Vice President of Investments at Crowd Street, overseeing the company’s online commercial real estate investment marketplace.
One of the most common ways I have seen investors invest in real estate is to purchase and operate one or more single family houses as rentals. It’s a logical approach for many investors as it’s a process they understand, having purchased their own home. In addition, owning a second home can be attractive as the purchaser has likely witnessed the equity in their home grow over time.
However, for investors seeking a more diversified and balanced approach to real estate investing, they may be better off rethinking this strategy and, instead, opting to build a portfolio of passive commercial real estate investments.
Challenges Of Owning Single Family Rentals
Owning and operating single family rentals is tough work and riskier than most people realize. It presents numerous challenges as an investment vehicle, including:
- Lack of sustainable cash flow:Unless you are purchasing without debt, single family rentals produce little to no sustainable cash flow in most markets. Investors typically justify this by acknowledging they are really making a mid-term bet on a housing market. This places the entire focus of the return on appreciation of a market.
- Excess risk:If leveraged, owning a single family rental requires the investor to assume more than a 100% loss of equity risk by taking on recourse debt. This is a substantial element of risk that investors often overlook. In a downside scenario, a rental owner could be on the hook for far more than their original investment.
- Lack of economies of scale:There are a lot of large capital items, such as roofs, driveways, heating and cooling systems, etc. that are only used by one tenant. If a rental incurs unforeseen capital costs, it wipes out any cash flow for the foreseeable future and it can tank future profitability.
- Binary occupancy (100% or 0%):Accordingto Freddie Mac, U.S. multifamily occupancy rates have averaged approximately 95% dating back to 1990. Therefore, large multifamily properties can reliably target 95% occupancy rates in most markets. In contrast, a single month of vacancy in a single family rental equals a 91.75% occupancy rate (or 8.25% vacancy rate) for that year. If the house remains vacant for three months, you are now facing a 75% occupancy rate for the next year, which is equivalent to a seriously distressed multifamily property.
- Costly management:You are either forced to manage the asset yourself at a large opportunity cost to you or pay a large percentage of income (typically 6-10%) to a third party to manage it for you. Either scenario is an undesirable time or cost expense.
- Purely market dependent:Asset value has no correlation to its profitability and is solely dependent upon the overall market.
- Backyard reliant:Due to owners’ desires to maintain direct oversight of single family rental homes, the location of those rental homes is often within a short drive of their personal residence.
These inherent challenges make single family rentals difficult to justify as a portion of a diversified portfolio strategy.
Passive Commercial Real Estate Investing As An Alternative
Once investors begin to understand passive commercial real estate investments, it’s not uncommon to see them move away from owning single family rentals to redeploy their capital across a number of deals. While it’s not impossible for an investor to become a direct owner/operator of commercial real estate, the specialization and amount of capital required to do so typically poses a formidable barrier to entry. As a result, investors can now opt to invest as a limited partner with commercial real estate operating companies. The following are some of the reasons I see investors choosing to do so:
- Asset value correlated to net operating income (NOI):This is the single greatest reason why an investment in commercial real estate is fundamentally different from a single family rental. The fact that the value of a commercial real estate property has intrinsic correlation to its net operating income means that you can make (or lose) money in a deal regardless of what the greater market is doing. This gives commercial real estate a business model. It also puts the operator in far greater control of its own destiny and moves away from a model of simply making a bet on a market and hoping for the best.
- Ability to co-invest with professionals:Once investors are ready to embrace passive investing, they can now seek out sophisticated groups with proven track records. This gives investors the ability to mitigate some risk by teaming up with battle-tested investing veterans.
- Diversification:Diversification in any asset class is a fantastic tool, and real estate is no exception. By passively investing through real estate operators, investors are now able to freely select asset type, geography and business plan. There’s almost no limit to what they invest in and where they invest.
- Loss limitations:In contrast to single family rentals, as a limited partner, the investor’s liability is capped at the investment amount.
- Rationality:The competitiveness of commercial real estate is typically grounded in rationality (e.g. proximity to transit, ingress/egress, loading, suite size, etc.), which, while complex, can actually make it possible to more reliably project a property’s performance.
Business Vs. Investment
My point is not to bash the concept of owning single family rentals — I have owned them myself and benefitted from the experience. Single family rentals can be a good place to start off in real estate investing. However, I advise investors to view them more as operating a small business than making an investment because that is what it will feel like a year into it. The extremely hands-on nature of owning rentals can easily morph the original intent of the purchase and leave investors with a valuable learning experience rather than a yield and a realized return. It all depends upon the path you wish to take in your journey to becoming a sophisticated real estate investor.
Phoenix Commercial Real Estate and Investment Real Estate: Investors and Owner / Users need to really know the market today before making a move in owner user Commercial Properties, Investment Properties and land in Phoenix / Maricopa County, Pinal County / Arizona, as the market has a lot of moving parts today. What is going on socio-economically, what is going on demographically, what is going on with location, with competing businesses, with public policy in general — all of these things affect the quality of selling or purchasing your Commercial Properties, Commercial Investment Properties and Commercial and large tracts of Residential Land Therefore, you need a broker, a CCIM (Certified Commercial Investment Member) who is a recognized expert in the commercial and investment real estate industry and who understands Commercial Properties and Investment Properties. I am marketing my listings on Costar, Loop-net CCIM, Kasten Long Commercial Group. I also sold hundreds millions of dollars’ worth of Investment Properties / Owner User Properties in Retail, Office Industrial, Multi-family and Land in Arizona and therefore I am working with brokers, Investors and Developers. I am also a CCIM and through this origination ( www.ccim.com ) I have access to marketing not only in the United States, but also internationalClick here to find out what is a CCIM: https://en.wikipedia.org/wiki/CCIM
Please call or text me on my cell: 520-975-5207 or send me an e-mail firstname.lastname@example.org
- DEMOGRAPHIC FACTS ABOUT MARICOPA COUNTY:
- The average age of the population is 34 years old.
- The health cost index score in this area is 102.1. (100 = national average)
- Here are some of the distributions of commute times for the area: <15 min (22.7%), 15-29 min (36.8%), 30-44 min (25.1%), 45-59 min (8.6%), >60 min (6.8%).
Feel free to contact Walter regarding any of these stories, the current market, distressed commercial real estate opportunities and needs, your property or your Investment Needs for Comercial Properties in Phoenix, Tucson, Arizona.
Kasten Long Commercial Group tracks all advertised apartment communities, including those advertised by other brokerages. The interactive map shows the location of each community (10+ units) and each location is color coded by the size (number of total units).
Walter Unger CCIM, CCSS, CCLS
I am a successful Commercial / Investment Real Estate Broker in Arizona now for 20 years. If you have any questions about Commercial / Investment Properties in Phoenix or Commercial / Investment Properties in Arizona, I will gladly sit down with you and share my expertise and my professional opinion with you. I am also in this to make money therefore it will be a win-win situation for all of us.
Please reply by e-mail email@example.com or call me on my cell 520-975-5207
Walter Unger CCIM
Senior Associate Broker
Kasten Long Commercial Group
5110 N 40th Street, Suite 110
Phoenix , AZ 85018
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