Passive Income—The Goldmine of Commercial Real Estate Investing
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Passive Income Makes Me Want To Dance...or something. photo by corey robinson
Passive income is the money generated from real estate or business transactions in which the investor is not actively involved. There are several ways to generate passive income from investments in commercial real estate. To understand the value of passive income, it is important to understand how income is generated from commercial real estate.
Commercial Real Estate Income—Understanding Valuation
Commercial real estate is valued in a different way from residential real estate in that the property produces income directly proportionate to its 
worth. This means the property is worth more if it creates more income. Residential real estate is valued based on comparable real estate in the area, otherwise known as market comps.
Generating Cash Flow
Commercial real estate investment also generates greater liquidity through larger cash flow. For example, if you were to invest $250,000 in a residential home, you would expect to rent that house for $1,800 while the underlying mortgage payment would be around $1,600. This would leave you with only $200 in profit with all risk resting on one tenant. If you were instead to purchase a 10-unit two-bedroom apartment building at an investment of $25,000 per unit and rent each unit for an average of $500, you would generate $5,000 per month while spreading the risk among 10 tenants. That is a little over three times the amount of cash generated for the same amount spent.
Forced Appreciation
With commercial real estate valued at its ability to produce income, you can increase the value of the property (appreciation) through increasing income. If you cosmetically upgrade a property through inexpensive updates, you can increase the value of the rents. If you decrease costs of maintenance or pass some maintenance expenses to the tenants, you increase the income from the property. Many small tweaks can generate a much higher income and value of the property.
Passive Income
Commercial real estate investment generates passive income when a person acts as a silent partner, invests in an investment pool or invests in a Real Estate Investment Trust (“REIT”).
A silent partner investment can provide high reward but can carry a high degree of risk. Silent partners usually provide cash or access to capital but do not manage or participate in the daily operations of the property. Generally silent partners may not mandate business decisions but can require accountings of their investments. Silent partner agreements exist at many levels from limited liability corporations, limited liability partnerships or partnerships. These can be extremely lucrative business ventures but require a substantial amount of research to find the right fit for the investor.
Investment pools are created when a group of investors pool their assets to own property. The investors do not participate in managing the property or any activities associated with the property. Income dividends are paid directly to the investors minus fees and other stipulated costs. Some investment pools are heavily structured while others have more fluid rules. These can generate substantial income for investors depending on the structure and policies of the pool.
REITs provide a regulated market for investors to purchase securities sold on national exchanges that directly invest in real estate via mortgage or properties. REITs offer tax considerations that can eliminate or substantially decrease corporate income taxes. They can be public or private. Some REITs invest in multiple types of commercial real estate and some focus solely on one area. REITs are required to pay investors, at applicable tax rates, 90% of the income.
REITs are designated as mortgage, equity or a hybrid. Mortgage REITs focus on ownership and investment in property mortgages with revenues generating from mortgage loan interest. They purchase mortgage-backed securities, existing mortgages or provide loans to real estate owners. Equity REITs own and invest in property, which means the investors retain the value of the real estate asset. Income is generated from rents. Hybrid REITs provide a combination of mortgage and equity REITs.
Would you like to know more about Passive Investment Income Opportunities?
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4 Comments
April 22nd, 2009 at 9:31 pm
Rob,
I hope you are doing well.
In your example under generating cash flow you mentioned buying a ten unit apartment building for $25,000. I think you ment $25,000 per unit or a total of $250,000.
Victor
April 23rd, 2009 at 6:49 pm
Great post- it’s always it is important to understand how income is generated from commercial real estate.
May 22nd, 2009 at 1:23 am
You are right Victor…thanks for catching that!
July 27th, 2009 at 2:02 pm
very good post, we need more people to be educated on commercial real estate and how income is generated from it