We have all heard people promising amazing returns in commercial real estate. “Earn 15 or 20% if you invest with me.” What can you realistically expect to earn in a commercial real estate investment?
While it’s going to be a challenge to give you everything you need to know about investing in CRE in this article, lets hit the highlights. What is cap rate? That is short for capitalization rate. If you bought a bond for $100,000 and it gave you a return of $10,000 a year, you would have earned a 10% return on your money. Income divided by the investment is the cap rate. Just change the investment from a bond to a duplex, and that return would give you a 10% rate.
What is a cash on cash return? It means your return based upon what your cash investment is into the property. Let’s use the earlier example. You have a $100,000, and the bank wants you to put down 20% ($20,000). You finance $80,000 for 20 years at 5% interest.
Your income is $10,000, less your debt service which is $6,336 a year. So your cash flow after debt service is $3,664. That means your cash on cash return is 18% ($3,664 ÷ $20,000). That’s looking pretty decent. Compare that to the rate you are getting on your money market account today. However, there are many other items to consider. Maintenance, taxes, insurance, bad tenants, property management, financing, balloon notes, snow removal, landscaping, and tenant expirations.
People come to me all the time and say they want to own commercial real estate because it’s a “passive investment.” Don’t believe that for a second! Owning real estate takes work, whether you do it or someone else does.
Real estate is great as part of a person’s investment portfolio. But be careful out there. Make sure that when you invest in real estate, you have an experienced broker to assist you. If you want to discuss more about real estate investing in the Kansas City area, give Dan a call at 913-219-7430.