So you want to become a real estate investor, eh?

As this is my first blog, let me begin this post by qualifying myself.I am new to real-estate investing as a profession but not new to the idea of investing.I’ve romanticized endlessly, like many of you, about becoming an overnight real-estate tycoon.After nearly 20-years of living the dream inside Corporate America, I decided to finally do something about it.I’ve managed to save a little money to buy my first investment or two and I’ve chosen to chronicle my evolution from Software Product Manager to Entrepreneur. One of my first lessons learned so far is that this will be a rather drawn out evolution so grab your popcorn and enjoy the show.

My purpose of recounting this evolution is two-fold.First, as any Business 101 class will teach, every startup needs to have a business plan. As part of that plan, entrepreneurs need to understand their markets they will compete in before dropping a bunch of money down the toilet.As I recently learned in a local investor seminar, the first rule of real-estate investing is to protect your capital (The first rule of fight club....).So my intention is for these blog posts to serve as the content and market discovery for my business plan so that I can reduce my risk and have a better chance at protecting my initial capital. Second, since real-estate investing is so romanticized in our society today I hope to dispel the myths and frauds that are so prominent. This second point is a rather interesting one and will serve as the basis for a future blog.

So let's start at the beginning by deciding on which market to invest in.

Residential or Commercial?

One of the first questions a newbie investor should ask themselves is whether to invest in residential or commercial real estate. There are pros and cons to each and subsequent strategies that follow depending and this choice. Too many investors just starting out overlook the commercial market altogether and dive straight into residential investing simply because they have familiarity with the process from buying their own home. This isn't a bad strategy, afterall Warren Buffet preaches to invest in what you know and understand. I started down this path fruitlessly and spent several months analyzing deal after deal that I came across in my local MLS. Unfortunately for me, my timing was off; however I needed to go through this exercise as part of my market discovery to reach my own conclusions.

You see, I live in a suburb of Dallas, TX which is exploding right now due to the import of more than 130,000 people last year and the relocation of and investment by corporations such as Toyota, FedEx, and Nebraska Furniture Mart; the exact reasons I wanted to get into rentals in the first place. Market data showed inventory was low and buyers were being forced into rentals. The flip side was I was competing with cash-rich consumers moving here from California that were bidding the prices up with multiple offers and I couldn't justify making an investment at inflated prices. The returns weren't there and I was convinced this was hopeless until a neighbor introduced me to commercial investing. My analysis by the way was based on some great insights in Real Estate Investing 101 and 102

"Be fearful...": The case for Commercial

Many argue that commercial investing is more risky due to longer vacancy periods and/or longer sales cycles; a property can go vacant or unsold for a year or more. I was able to justify commercial investing to myself because of a stronger competitive environment for residential and having headed The Oracle's warning: "Be Fearful When Others Are Greedy and Greedy When Others Are Fearful".

Basic investment principals, such as know your time horizon and diversification, still apply to real-estate investing regardless of property type. If you can't afford to have your money tied up for 10 or more years, you shouldn't be investing in real-estate to begin with. As for the vacancy periods, this risk can be reduced by investing in mult-tenant properties where only fractions of the overall square footage are vacant at any given time. Admittedly, some commercial properties are inherently riskier than others and the astute investor should be aware of what makes them risky and how to identify the level of risk. In general though, commercial properties have more levers for an investor to control and manage the risk and overall profitability, especially when it comes to lease terms. Commercial tenants tend to sign longer lease terms than residential tenants which have both positive and negative outcomes. You're trading off the ability to raise rents for the security of a longer lease term however one can stairstep rent increases into a multi-year contract and offer extended lease options to incent a timely and reliable tenant to resign.

There were numerous other reasons commercial investing appealed to me. First, the market is more rational. Property valuations are driven by the principals of supply & demand and risk & return not by emotions. If a multi-tenant property is 100% occupied with reliable tenants holding multi-year leases, you can expect a lower return on your investment than a vacant single-tenant gas station that might have hidden environmental issues requiring costly remediation.

From a landlord perspective, commercial investing brings fewer headaches. For starters, your hours are your tenant's hours so you can expect not to be bothered in the middle of the night. Secondly, your tenants actions are aligned with your investment. Tenants are incented to take better care of the property because they want to present their business and storefront in the best light. Third, as indicated earlier, commercial tenants tend to be more timely and reliable with rent because their livelihood and investment are on the line.

Don't let me persuade you. Commercial investing isn't all roses. There are other risks that don't exist with residential. For one, there's the risk of the different loan programs available to investors such as loans with balloon payments and the risk of terms and interest rates on commercial lending. I will go into these in more detail in a future blog post. Other blog ideas include what I have learned so far about the different ways to invest in real estate and how to navigate the residential investing circus.

So stay tuned as we learn together, this should be about as much fun as having a root canal!