Residential/Commercial Buildings

6 Replies

BP -

I generally look at standard 2-4 family MFR investments, but the returns on 5+ unit res/com are very appealing. (ex: 7 unit building with 2 storefront and 5 1 bdrms). What sort of risks should I be considering that may not be different from the standard 2-4 unit multi? I'd love to hear from your past experiences, especially if you've had dealings in both res/com

@Victor Eng  

Depending on your market, it can vary greatly. I would definitely talk with @Matt Faircloth  as he has good experience with mixed-use multi-families in the Northeast. You may not be looking in the NE. Regardless, if you can cut it here, you can probably make it happen where taxes are lower and land is cheaper.

Hey @Victor Eng great question.  Have you ever lived in an apartment above a restaurant, dry cleaner, barber shop, etc?  If not, what do you think would be issue for a tenant?  This are the things you need to think about with mixed use.  I am not saying it doesn't work, it does, but be aware of who is ok renting based on the businesses that are there.  Also, higher down payment, insurance is different, and so on.

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Hi Victor,

@Trevor Ewen  thanks for pulling me into this conversation!

Things can change when you get into larger buildings but it depends on how you are currently structured.  If you are laying very little down and getting Fannie Mae backed money for your purchases of 2 to 4 unit buildings, you won't be able to do that moving up in size.  That being said if you are using financing from a bank (I prefer small banks based in the area around the property) you will be paying 25 to 30% down even for a duplex and it's the same on larger deals also.  We purchased an 18 unit building and a 10 unit building last year, both at 25% equity.  Rates were very comparable too, in the low 4% range.  You won't get a 30 fixed mortgage on these types of properties though, most loans have a rate adjustment every 5 years.  If that was the type of financing you got on your smaller multis, there is little change in larger deals.

With regards to building a building with a storefront, as @Sean T.  said it depends on the business.  This is true both because people may not want to live over certain businesses and also because you want to evaluate the stability of that business.  A retail tenant is completely different than a residential tenant.  The business itself is what is paying the rent.  If the company is well run, well marketed, has a solid track record and following, and a solid lease, good for you.  Filling a commercial space can be challenging as you need to get the right tenant.  A vacant storefront can sit for months while you wait for the right occupant. And, unlike an apartment people don't just "move in" to a storefront. They need to setup the space to accommodate their business, this is called "fit out".  A savvy retail tenant will want to pay you a small portion of the rent while they get the business ramped up.  

And one more thought - larger buildings require more work to keep them healthy and a more complex budget.  Make sure to include a "capital reserve" to set aside money for larger improvements like boiler or roof replacement.

I hope that helps!

Matt

@Sean T.  @Matt Faircloth  

Thanks for the amazingly good input. I am not too concerned on the financing side of things, but I completely missed the effect on scope of tenants willing to rent the place if there is a business operating underneath. These are valid points especially if we are talking about any foodservice business or anything with heavy customer traffic. 

But I assume rejecting a tenant based on the business they plan to operate is not illegal? Understand this narrows the scope of commercial tenants, but I'd much rather prefer an accounting firm etc instead of a bakery. 

@Trevor Ewen  Thanks for looping Matt in!

Hi Victor,

Residential tenants have many protections including the benefit of the courts during eviction, a limit on how much security you can hold, and on what you can base a rejection of their application.  

None of these things, and many more factors, apply to commercial real estate.  You can reject an applicant for your commercial space for any number of reasons including that they would not be a good fit for your building.  I also get more security from my commercial tenants, most of the time 2 months rent.

I would not make this a deciding factor for your purchase.  What I would do is target buildings with a successful business on the first floor.  Once they are established and successful in that location, it's very hard for them to move.  People know where they are located, and as long as the space continues to serve them and you don't jack up their rents, they will probably stay for as long as you will let them.  I would look for a building with an established retail presence but dilapidated or under market residential units that you can rehab and increase rents on to increase cash flow.

Take care,

Matt