Although the state has a low migration rate, California is still one of the most populous states. Meanwhile, typical rent for an apartment in the Golden State is at least a thousand dollars.
This makes commercial real estate a lucrative source of long-term passive income here. However, it also demands massive capital. How can one afford it? Here are four options:
1. Apply for a Commercial Real Estate Loan
One of the simplest ways to afford a commercial property is to apply for a loan. But programs can significantly vary. It can benefit the applicant to look for companies that can extend a commercial real estate loan.
The choices are already tailor-fit to the needs and budget of their target market. For example, for those with a limited budget, these companies can provide a loan worth at least a million dollars, which can already purchase an apartment with about 5 units.
Often, the rates for residential units like apartments are lower than those for retail buildings and office spaces. There can be a difference of at least 0.5% to 1%.
Some organizations rely on their vast network of traditional lenders such as banks and non-traditional ones like private investors that can give more loan options. These include bridge money loans or hard money financing.
2. Make the Most of Exchange 1031
A person who sells their real estate may have to pay capital gains tax if the purchase price is higher than the investment value. California doesn’t distinguish the realized gains as either long-term or short-term.
Instead, the amount is according to the taxpayer’s income and tax bracket. But the rates can be from 1% and 13.3%. It can be huge money to pay for someone who’s just starting with real estate investing. After all, 10% of a million dollars is $100,000.
Further, this isn’t the only tax they need to pay. Anyone who holds such kind of property may also have to pay property tax.
An investor may be able to hold off paying that with the 1031 exchange. According to the IRS, a person may defer paying capital gains tax if they “exchange” or sell their assets for like-kind properties.
Note, though, that the definition for “like-kind” has already changed over the years. Today, investors can already let go of a rental house for a five-unit apartment building.
A person or agency may also choose up to three properties they can exchange for the asset they currently have as long as they can close one of them. They may opt for more replacement properties as long as their total market value does not exceed 200% of the original asset.
In the 1031 exchange, the seller needs to turn over their capital gains to a qualified intermediary, identify a property for exchange within 45 days, and close the deal in 180 days.
The good news is as long as one can follow all these criteria, an investor can avoid paying capital gains tax for years while realizing passive income on the investments they purchased.
3. Participate in a Real Estate Investment Trust (REIT)
Real estate investment trusts (REITs) work similarly to mutual funds. Investors, who are usually individuals, pool their resources to invest in various real estate types. Some REITs, though, specialize in particular sectors, like healthcare, retail, and education.
Under REITs, investors do not earn through capital appreciation. Instead, they receive dividends from the sale and rental of the real estate portfolio. They also don’t need to manage, maintain, and buy and sell any of these assets.
Investment income through REITs is also liquid, unlike actual real estate. In other words, if the investor is going to need money, they can liquidate their dividends in days. Compare that to selling real estate, which can take as long as 65 to 90 days.
4. Buy a Distressed or Foreclosed Property
These types of commercial properties are often cheap for a couple of reasons. With distressed real estate, previous owners may no longer afford the upkeep. Keeping the asset for a longer period may only result in more losses.
Meanwhile, with foreclosed ones, lenders usually choose to recoup the unpaid balance than to realize a gain or a profit from the sale. Auctions will also give real estate investors access to an array of commercial assets.
Those who like to buy a commercial property need to be realistic: it will never be as cheap or even more affordable than residential real estate. However, getting one doesn’t have to cost a lot.
With the ideas above, potential commercial real estate investors can consider various options to own an asset and achieve their dream of generating passive income.