Commercial vs Residential

21 Replies

I have a small residential portfolio which I have enjoyed and would like to continue to grow. Commercial investing has always interested me, although I have heard its a much different animal. I have a residential license and know that side of it pretty well. My question is: is commercial investing that much different? Do most investors usually stick to one or the other? I would appreciate any feedback.

Thanks!

Totally different universe.

Depends on the asset class within commercial and the loan size and scale of the property.

@Josh Bishop

What interests you about commercial? Why would you want to invest in commercial as opposed to residential. I think it's important to specialize in one or two assets classes as opposed to trying to do everything. Especially if you are a smaller investor without a large team in place. There are a lot of ins and outs to every asset class. Commercial generally has more sophisticated investors with deeper pockets than small residential. That means you have to be on top of your game to ensure successful acquisitions and management. Smarter and healthier sharks swim in those waters. Hence my reasoning to specialize. I think if you are going to switch to commercial you need to spend some time understanding the asset class which you are going to invest in. The financial side is more intense and lending parameters are different. I would connect with other investors in your area that invest in your desired asset class. Possibly invest in a deal they are doing to get guidance and experience.

Commercial and large multi-family residential projects appeal to me much more than residential 1-4 units. I prefer dealing with more sophisticated investors, professionals, and vendors. Economies of scale are also important to me as opposed to a single family.

Hi

I am almost close to 10 mortgage limit, is it better to go for multi family now or go for Blanket loan and buy more single family?

@Shital Thakkar

This could be a completely different thread however that really depends on your goals. Are you looking for cash flow or appreciation? Or both? It is really difficult to cash flow single family houses over a 10-20 year period. IF all the houses are close by each other then that could help bring down costs a little. It is extremely difficult to manage a large number of single family houses. Even if you have a property manager in place, managing the manager is difficult when going through checks and balances. It's also difficult to go through so many periodic rehabs at different locations over the years. If you are looking for cash flow then multi-families make much more sense over the long term. If you are banking on appreciation then single families with lower returns in the right areas might be a better fit. Single families can be easier to liquidate and give you the ability to cash out one by one as opposed to multi-family. However multi-family is generally liquid in the right market at the right price. And you could always refinance to pull cash out if needed. Larger multi-families also give you access to more professional property managers and economies of scale. If you need to do a total upgrade at your 100 unit multi-family it will take a lot less of your time than renovating 100 single family properties. At the end of the day it comes down to your goals. How much do you want to grow?

@Chris Winterhalter You mention that those who invest in commercial real estate have deeper pockets, so is there any restriction on who can or can't invest in them. Obviously a bank would want to see your financial statement or other indicators of your financial IQ (right?), but is there any limit SEC wise preventing non-accredited investors from investing?

I'm just curious and not investing yet (I'm 15)... Thoughts?

@John E.

The SEC deals with securities not the direct purchase or sale of real estate. We have the freedom to purchase or sell just about anything (within the laws) in the United States without restriction to income or social class if the selling party agrees to sell and you have the cash to purchase the asset/item etc.

Pooling outside investor funds is where the SEC comes into play. When you pool funds to purchase real estate you are creating a security or tradable asset. Because of that you are subject to the SEC's rules and regulations.

Anyone can buy a commercial property with the right resources and sufficient capital. However you traditionally find more sophisticated and experienced players in commercial...that isn't always the case however more so than single family investing. Buying a single rental property as an investment is much easier for the average person than buying an office building.

Congrats on being 15 and having the desire to learn about real estate. Good luck!

@Chris Winterhalter Duh! What was I thinking! Securities and exchange commission! So they can regulate the sale of securities & raising capital, but anyone can buy a property if they follow the laws. Got it!

Isn't the ability to buy and sell property outlined in the constitution? I think it's called free alienation of property. I remember taking an online course that referenced this.

Oh and thank you Chris for the compliment! Kind words from experienced investors that are living the dream means the world to me.

one of the biggest limitations in commercial investing is that you cannot get long term fixed rate financing. Most loans are fixed for 3-7 years. You may find fixed 15 year loans that amortize over 15 years, but that's about it. The other issue is that you may have long vacancy spells, or you may be stuck with a long term tenant at below market rates, if they get in at low rent levels (and leases are frequently 3-5 years, with extensions.) So at the end of the day, commercial is also a cyclical investment, and you must be comfortable with the specific risks.

Those are generalities, and you should compare them to the pluses/minuses of residential in your market. In my case, the San Francisco market, I am staying with residential (though I always contemplate trying a commercial property.) My current portfolio is about $4.5 million, but since property is so expensive out here, that translates to 8 units, which is manageable. I also do condo conversions and other tricky developments, which add a lot of value. And I plan to hold everything long term, since appreciation is golden here. Therefore, 30 year fixed rate loans are a cornerstone to my investing strategy, and something I cannot do with commercial. The other surprise in our market is that commercial gets over played and valued just like residential. It's not any easier finding sleeper deals in commercial than residential, so I'm sticking to what works best for me right now. That's my 2c.

@Amit M.

You're just not looking in the right places. Many banks are doing 10 year loans right now. 10 years is the industry standard for commercial loans written by CMBS shops and insurance companies. Also, insurance companies can routinely go out 15-20 years if they like a deal.

HUD loans can be 35-40 years.

You're not going to get a traditional 30 year self amortizing residential mortgage on your commercial property but there are lots of options out there beyond 3-7 years.

I should add that many of these loans will have 30 year amortizations, so your cash flow will be the near the same regardless.

I couldn't agree with @Amit M. more about the variable rate financing aspect, along with the differences in vacancy, especially if you have a single-tenant building, large single space, or unique building.

@Derek Carroll , it's true you can get longer amortization - like 25yr on most commercial, and 30yr am on Multifamily. But that means the same cash flow UNTIL THE FIRST ADJUSTMENT. The longer-term is a lot different.. The Bank takes a big share of your upside..

Lower headaches though when they are operating well, and NNN leases are nice for returns..

@Shital Thakkar and @Josh

@Josh Bishop undefined

There are also private lenders to blanket portfolio loans on SFR portfolios, in addition to B2R by Blackrock..

Good luck!

There is long term money for commercial.

Now the difference is if you are just getting started in commercial looking at a 1 million to 2 million property getting someone other than a local bank to fund it for more than 3 to 7 years fixed is tough.

I don't like the large loan amounts with personal guarantee, short loan term, and refi rate risk. The local banks push this crap because current CD payouts and savings is about 1% annually unless you are locking a ton of money for five years to get 1.75% which is nuts. They know that they can't do long term commercial loans. The loan balances are a high percentage versus the branches total deposits level.

In the coming years banks might pay 2,2.25, 2.5 percent or more on CD's and savings to attract money in. They can't survive on long term fixed commercial debt.

This is why I tell my clients look for owner finance deals with some down or we need to put partners together to go after a bigger deal where you can land non-recourse, long term loans, and a low fixed interest rate. It does exist in commercial but buyers need to understand a 1 million property is like a 50,000 house purchase to a large commercial loan investor. You can land non-recourse on corp guarantee tenants in the 1 mill to 2 mill range but generally not much yield there.

Best yield and loan terms I am seeing is on small strip centers lately.

my experience in San Francisco investing is that you really need some serious assets to launch into commercial. Residential in gentrifying neighborhoods still offers stronger turns, if you know how to optimize the variables by actively repositioning the property. I owned a commercial residential bldg (with a partner), which we did a lot split on, and now I have my own and seperate triplex out of that. Frankly I couldn't wait to get out of the commercial loan. Although the rate was great (thanks LIBOR :), it was recourse, which totally blows. I am never doing another recourse loan, I don't like the risk.

Also, simple things like getting insurance is a much bigger pain in the *ss than residential. They ask all sorts of questions, want to do inspections, etc. with residential I just call my Farmers guy, give him the deets, and in 20 minutes done. Plus the rate is usually lower too. You gotta remember that 1-4 units is mainstream stuff, so that means that prices are very competitive due to the sheer volume. Also, there are more government enforced regulations to protect you. The home insurance policies are more robust (especially for what you pay), you can get 30 year fixed loans due to the gov backing them up, etc. so it's nice to take advantage of all that as an investor.

And then the other issue is that the more "triple net" the tenant is, the more that building behaves like a bond or annuity, as you're locked in with limited rate increases for a longer timeframe. And if you're doing more short term, experimental stuff (mom/pop retail, restaurants, neighborhood services) then if a tenant goes bust you may very well have a long vacancy. I've seen it happen even in commercially active areas in SF. The owner is holding out for a high PSF rent because the economy is good, etc., and they don't want to get stuck with a low rent lease for 5 years.

Now don't get me wrong. I know numerous investors who have made multi millions in SF with commercial. But for me it's such a different animal that I find it not rewarding to just dabble in it. I'm still tempted every now and then by specific commercial properties I see come on the market, but so far it's not for me.

One thing to consider is that while we're almost hard wired to believe that rates must be going up at some point, we could actually be turning Japanese with the Fed caught in a liquidity trap that keeps rates chained near the zero lower bound for an extended period. Japan's Ushinawareta J?nen (Lost Decade) is getting to be two and a half and some observers believe the US has been heading the same direction since the turn of the century.

Since the dot com implosion in 2000 easing ahead of the Y2K 'bug' every time the Fed has tried to tighten it has caused a recession and they're forced to backtrack. If you are like me you've grown up in a time when inflation was the big concern. I (and maybe you too) have a hair trigger sensitivity to anything that smells like inflation but now the fight seems to be against deflation.

Historically this makes sense as well because as Reinhart and Rogoff pointed out in This Time Is Different, recovering from a debt bubble involves lower spending as debt is paid down and savings built up. The real danger is that it becomes a spiral of less spending that reduces the economy which leads to more savings which further reduces spending, rinse and repeat.

Net net, while my most innate instincts are to lock up the longest fixed rate debt possible the urgency may be more about my biases then the economic reality we confront. If the Fed is trapped at the ZLB investors who went with the lower rate short fixed term financing may do better.

For more on the Liquidity Trap and turning Japanese (not the song) see this by Tyler Durden at Zero Hedge and more recently this from Joe Calhoun over at Alhambra Investment Partners.

Good hunting-

One thing to consider is that while we're almost hard wired to believe that rates must be going up at some point, we could actually be turning Japanese with the Fed caught in a liquidity trap that keeps rates chained near the zero lower bound for an extended period. Japan's Ushinawareta J?nen (Lost Decade) is getting to be two and a half and some observers believe the US has been heading the same direction since the turn of the century.

Since the dot com implosion in 2000 every time the Fed has tried to tighten it has caused a recession and they're forced to backtrack. If you are like me you've grown up in a time when inflation was the big concern. I (and maybe you too) have a hair trigger sensitivity to anything that smells like inflation but now the fight seems to be against deflation.

Historically this makes sense as well because as Reinhart and Rogoff pointed out in This Time Is Different, recovering from a debt bubble involves lower spending as debt is paid down and savings built up. The real danger when this happens is that it becomes a spiral of less spending that reduces the economy which leads to more savings, rinse and repeat.

Net net, while my most innate instincts are to lock up the longest fixed rate debt possible the urgency may be more about my biases then the economic reality we confront. If the Fed is trapped at the ZLB investors who went with the lower rate short fixed term financing may do better.

For more on the Liquidity Trap and turning Japanese (not the song) see this by Tyler Durden at Zero Hedge and more recently this from Joe Calhoun over at Alhambra Investment Partners.

Good hunting-

As a property manager for retail strip centers on NNN (triple net) leases, I think commercial is a great way to go. Yes, it is very different from residential and the price of admission is higher. NNN leases are more complicated but are designed for getting the landlord a "net" profit. Management is supposed to be less intensive than residential because of the NNN but each property is different. The learning curve is steep, but you learned residential, right? No problem. Just read all the leases carefully, yes, all 60 or 149 pages! Then hire a competent commercial property manager, designations can certainly help (CSM, CPM). Other than the obvious, tell your manager to look out for liabilities (trip and fall, ADA stuff, etc.), you don't want to get sued. You should also hire a leasing broker. Since you're starting out, you should pay these guys to learn how to do it right them then do it yourself, if you want.

The commercial landlords I know who went from residential to commercial never looked back. I think the obvious two keys are location, location, location and having reserves (oops, that was four keys). Maybe you can pick up a shopping center for dirt cheap out in the middle of the desert but you're tenants will probably have a hard time making money and you'll have vacancies. That's when you'll need reserves to carry you through vacant periods and if you need any major upgrades (parking lot, roof, main line sewer problems).

What's different about commercial is it could be in a rough part of town but as long as it's on a busy retail area, the property can do fine. You might have to clean up graffiti every day but it could be a cash cow.

Originally posted by @Giovanni Isaksen :
One thing to consider is that while we're almost hard wired to believe that rates must be going up at some point, we could actually be turning Japanese with the Fed caught in a liquidity trap that keeps rates chained near the zero lower bound for an extended period. Japan's Ushinawareta J?nen (Lost Decade) is getting to be two and a half and some observers believe the US has been heading the same direction since the turn of the century.
Since the dot com implosion in 2000 every time the Fed has tried to tighten it has caused a recession and they're forced to backtrack. If you are like me you've grown up in a time when inflation was the big concern. I (and maybe you too) have a hair trigger sensitivity to anything that smells like inflation but now the fight seems to be against deflation.

Historically this makes sense as well because as Reinhart and Rogoff pointed out in This Time Is Different, recovering from a debt bubble involves lower spending as debt is paid down and savings built up. The real danger when this happens is that it becomes a spiral of less spending that reduces the economy which leads to more savings, rinse and repeat.

Net net, while my most innate instincts are to lock up the longest fixed rate debt possible the urgency may be more about my biases then the economic reality we confront. If the Fed is trapped at the ZLB investors who went with the lower rate short fixed term financing may do better.

For more on the Liquidity Trap and turning Japanese (not the song) see this by Tyler Durden at Zero Hedge and more recently this from Joe Calhoun over at Alhambra Investment Partners.

Good hunting-

If I could vote for this post 10 times, I would. The only difference is that I believe Tyler Durden is a perma-bear. Therefore, I no longer read what he has to say because it's always doom & gloom.

Josh, you received a lot of good advice above. Try to digest as much as possible. Post more questions if you have, and these gentlemen will help you out.

Thanks for all the great advice and information! I'm in the same place as @Josh Bishop also leaning towards commercial after being a residential buy and hold landlord for 8 years. It's exciting and frightening but so was residential at the beginning.

@Dale Shin , I love your comment, very reassuring :)

The learning curve is steep, but you learned residential, right? No problem.

Thanks @Minh L., agree with you about Tyler but I think he made some good points in that particular piece, especially when it comes to battling my own biases.

Sorry about the double posting, BP kind of weirded out on me when I was trying to post.

@Minh L. ... and it's not just me on the Japan thing. Ambrose Evans-Prichard at the Telegraph said this last week: "The US seems caught in a Japan-style trap, endlessly masking the effect by stealing a little extra growth from the future with artificial stimulus"

Then he had this: "Former Fed chairman Ben Bernanke said recently that long-term yields would never reach 4pc again in his lifetime, portraying a changed world where nothing returns to normal."

http://www.biggerpockets.com/blogs/5055/blog_posts/37898-interest-rates-must-be-going-up-soon-right

Good hunting-

wrt the turning Japanese thing, if you invest in the Bay Area, it's almost the best of both worlds.  Low interest rates for your properties, while our local economy is going gang busters, hence rents keep going up. It's the old adage, while interest rates effect the macro economic picture, what's happening in your local economy is often more relevant to your personal fortune. Of course longer term, persistent low/no growth is more the perma bear mentality, which I don't subscribe to. 

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