Commercial real estate is a whole other animal compared to residential investing. Commercial properties have different financing requirements and they have different formulas. One popular formula is the capitalization rate or cap rate. Cap rate is calculated by dividing the yearly income (subtracting fixed and variable costs) by the total value. The higher the cap rate, the better the return. Cap rates are used with net operating income to calculate value. Net operating income is calculated by subtracting operating expenses from operating revenue. The result is net operating income if positive, but net operating loss if negative. Cap rates are regularly reported in the real estate media, which is a testament to their importance.
Real Estate Investment Trusts (REITs)
REITs are traded on exchanges just like stocks. They are trusts that invest directly in residential and commercial real estate. Investors most often favor REITs over any other method of investing in real estate. Getting in and out of the market is as easy as buying and selling stocks. REITs are highly liquid and can pay high yields, giving investors a great return on their money. REITs can invest in physical properties, mortgage notes or both, giving investors more options. The high dividends are what attract investors to this asset class. The performance of REITs can serve as a proxy for the real estate market as a whole, giving investors a great set of indicators.
Single Family Residential
The ultimate objective for investing in single family homes is to realize the returns available from rental income and potential appreciation. Investing in multiple single family residential properties can achieve this goal, but unfortunately the costs may outweigh the benefits. Taxation, legal hurdles, ownership documentation and other paperwork requirements eat into the value of the property and any rental income it generates. The value to the investor is lost in the bureaucratic regulatory structure, which magnifies costs in a recession. Single family residential investing is better left to more favorable times.
Multifamily residences have an advantage over single family residential properties. The various economies of scale cut down on costs while maintaining profitability. The total cost to purchase is lower per square foot than with multiple single family properties. Additionally, the fact that multiple families use the same property means that the total income from that property is higher than with single family homes. Costs are lower and income is higher; this is a great deal for any investor. Spreading costs out over multiple units also means the unit price is lower. Multifamily residential properties avoid many of the issues associated with residential investing.
Mobile homes are a unique opportunity for real estate investors, especially compared to single family homes. Rents are caught in a downward spiral thanks to oversupply. Investors are actually lowering rents to attract tenants and beat the scourge of vacancy. Mobile homes are in a different situation thanks to their high moving costs. Typically, the cost of moving a mobile home is $3,000. No one wants to pay $3,000 in response to a rent increase of $10 or $30 per month. This makes rents more flexible for investors.
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