Why commercial over residential?
Peter TverdovBusiness Member
Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votesWhy commercial over residential?
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Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes
9yHi Peter! Lots to say here, so I'll try to make it (somewhat) brief and then we can chat further, if you'd like.
Nothing against residential by any means, but here is what I see as the advantage to commercial.
First, I don't find financing to be terribly different. I'm not sure why you are running into an issue, maybe the mixed use or low occupancy, but just being commercial shouldn't cause problems. 25 or 30 year amortization is pretty common, often with a shorter term and balloon at the end, but the longer amortization I haven't had the same experience. And rates are not really higher unless you are getting some kind of FHA or other assistance program on the residential, in which case you probably would have to own as an individual, not an LLC, and the more units, the more liability typically, so that's not always in the owner's best interest. As far as rates, we're closing in the high 3's, low 4's. Adjustables are running something like .5-2% above the prime. Not too different from where residential lending numbers are right now.
There are tremendous benefits to NNN or NN leases, so it depends on the types of leases presently in place in that building. Mixed use comes with some unique benefits and challenges. I wrote an article about it in a trade magazine that I have posted on my blog on here, or I can send you the link. So that's a whole different ballpark, but commercial tenants are usually, to be candid… less annoying. Less midnight "my toilet is clogged or my window is drafty" calls, less "I can't pay you this month because my sister's boyfriend's cat died and blah blah…", no "I didn't pay for renter's insurance because I didn't actually read my lease", etc. Like you mentioned, you typically get longer term leases, and unlike a residential tenant who can move their couch and bed anywhere pretty easily, commercial tenants typically improve their space in the manner required to run their business, so booths and counters and built-in shelving in a restaurant, or barber chairs and expensive built in mirrors for a salon, etc. so the likelihood they pick up and leave when they have invested in your property isn't as great. Depending on the size apartment and the rent amount, it makes sense that if someone is renting an $1,000/mo apartment and can't pay rent, that going after them for a judgment won't get you very far. Your ability to go after a commercial tenant with a personal or corporate guaranty or that runs other businesses, much more incentive for them to do what they are supposed to, and most likely you'll have a much bigger deposit than a small residential apartment.
Then there are the huge number of rules that pertain to residential landlords that don’t apply for commercial. Shorter notice periods, no adjournments of evictions for hardship, no rent control, no special rights that a residential tenant has under both federal, state and local laws, which all are extremely tenant friendly. Commercial isn’t like that.
And lastly, like I mentioned above with regard to the NN, NNN concept, you can pass through so many costs to commercial tenants in addition to their significantly higher ppsf monthly rent (again, usually, most neighborhoods…not all), like cleaning services, landscaping, signage, utilities for common areas, insurance, taxes, even re-facing a parking lot or repairing side walks can often be passed through to the tenant through "CAM" fees. Plus, you can usually require the tenant to carry their own insurance and just name you as additional insured. Commercial is just much more hands-off, less turn-over (usually), and a lot of upside.
Other people might have a totally different opinion, but before I got more heavily into residential, I worked almost exclusively on commercial development, from single free standing stores, to $100,000,000 retail centers, so maybe I just have a strange fondness for them! I do get a little bit too excited when I see a well designed strip center J Now I do both commercial and residential (investments, not personal purchases for the most part), and I have to say, that from a risk/benefit standpoint, I personally still favor commercial if you have the capital to make it work.
66 Replies
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y
Hi Peter! Lots to say here, so I'll try to make it (somewhat) brief and then we can chat further, if you'd like.
Nothing against residential by any means, but here is what I see as the advantage to commercial.
First, I don't find financing to be terribly different. I'm not sure why you are running into an issue, maybe the mixed use or low occupancy, but just being commercial shouldn't cause problems. 25 or 30 year amortization is pretty common, often with a shorter term and balloon at the end, but the longer amortization I haven't had the same experience. And rates are not really higher unless you are getting some kind of FHA or other assistance program on the residential, in which case you probably would have to own as an individual, not an LLC, and the more units, the more liability typically, so that's not always in the owner's best interest. As far as rates, we're closing in the high 3's, low 4's. Adjustables are running something like .5-2% above the prime. Not too different from where residential lending numbers are right now.
There are tremendous benefits to NNN or NN leases, so it depends on the types of leases presently in place in that building. Mixed use comes with some unique benefits and challenges. I wrote an article about it in a trade magazine that I have posted on my blog on here, or I can send you the link. So that's a whole different ballpark, but commercial tenants are usually, to be candid… less annoying. Less midnight "my toilet is clogged or my window is drafty" calls, less "I can't pay you this month because my sister's boyfriend's cat died and blah blah…", no "I didn't pay for renter's insurance because I didn't actually read my lease", etc. Like you mentioned, you typically get longer term leases, and unlike a residential tenant who can move their couch and bed anywhere pretty easily, commercial tenants typically improve their space in the manner required to run their business, so booths and counters and built-in shelving in a restaurant, or barber chairs and expensive built in mirrors for a salon, etc. so the likelihood they pick up and leave when they have invested in your property isn't as great. Depending on the size apartment and the rent amount, it makes sense that if someone is renting an $1,000/mo apartment and can't pay rent, that going after them for a judgment won't get you very far. Your ability to go after a commercial tenant with a personal or corporate guaranty or that runs other businesses, much more incentive for them to do what they are supposed to, and most likely you'll have a much bigger deposit than a small residential apartment.
Then there are the huge number of rules that pertain to residential landlords that don’t apply for commercial. Shorter notice periods, no adjournments of evictions for hardship, no rent control, no special rights that a residential tenant has under both federal, state and local laws, which all are extremely tenant friendly. Commercial isn’t like that.
And lastly, like I mentioned above with regard to the NN, NNN concept, you can pass through so many costs to commercial tenants in addition to their significantly higher ppsf monthly rent (again, usually, most neighborhoods…not all), like cleaning services, landscaping, signage, utilities for common areas, insurance, taxes, even re-facing a parking lot or repairing side walks can often be passed through to the tenant through "CAM" fees. Plus, you can usually require the tenant to carry their own insurance and just name you as additional insured. Commercial is just much more hands-off, less turn-over (usually), and a lot of upside.
Other people might have a totally different opinion, but before I got more heavily into residential, I worked almost exclusively on commercial development, from single free standing stores, to $100,000,000 retail centers, so maybe I just have a strange fondness for them! I do get a little bit too excited when I see a well designed strip center J Now I do both commercial and residential (investments, not personal purchases for the most part), and I have to say, that from a risk/benefit standpoint, I personally still favor commercial if you have the capital to make it work.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
@Peter Tverdov, @Jessica Zolotorofe
I am wondering that exact question today... Take a look at this one... You need to put $600K down, get $75K in rent, $50K of which will go to interest payment.... In essence you are getting $25K on $600K investment... Let alone the low to zero appreciation, and risk when the least team come up....
For taht same $600K, you can probably get more $25K and more than zero appreciation....
In today's interest rate enviroment, this deal only makes sense for someone who has $1.6m sitting in a bank making 0.00001% interest... But not for anyone who has to finance the purchase....
http://www.loopnet.com/Listing/20042621/942-E-Broadway-Road-Tempe-AZ/
- Investor · Austin, TX · Member since 2013 · 933 posts · 1k+ votes9y
Peter,
Not so sure on your approach and findings but in general the more units under one building the less cost per sq ft and per unit. You start getting into economies of scale and w/the larger you go in # of units the more concepts like forced appreciation apply. The latter advantage is simply the way commercial property is valued over residential property. With residential, I really can't modify the home much as my values are tied to comparison properties. However, value in commercial is more tied to income from the property. So, I can get very creative and find value add opportunities like renovating the units, retrofit plumbing to reduce utility costs, add carport parking and charge a monthly fee, etc. Now, here's why folks like commercial. If I increase the NOI by creating more revenue or reducing expenses and say I increase it by $50K. If the cap rate on that building is a 7 cap, then I've increase the value on the property by $714K !!! That's why folks who own and create value in commercial space love it, I can't do that w/SFRs even if I have 100 of them.
- Rental Property Investor · Honolulu, HAWAII (HI) · Member since 2011 · 4k+ posts · 2k+ votes9yJust look at the people who do it. SFH people make it into their job. MFH they have the freedom to do other things. It's all scalability.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
I generally do not like mom and pop commercial which is generally sub 2 million properties. By nature the better urban core to strong suburban areas have higher rents per sq ft which makes the purchase prices higher.
Diane G. what you are looking at on Loopnet is overpriced junk. 4.5 cap rate with 6 years left on primary for a Jack in the Box is laughable. Really laughable.
I look at thousands of properties a week nationally for clients. That property I wouldn't even waste a second on it.
If you are going to do a 4.5 cap then go for a Starbucks with a 10 year lease, a Mcdonald's with a 15 year lease, or a Chick Fil A with a 15 year lease. Much, much better credit profiles.
I like commercial because I like businesses. I do not enjoy residential tenants on any level. That is why I focus on retail pretty much 100% these days as a principal broker and a developer. I enjoy the space immensely.
I was looking at an off market property today for a client for 5.4 million. Brand new 10 year leases for T-Mobile, Starbucks, and Aspen Dental on a hard corner with a traffic light next to a mall. Cap rate at about 6.8 going in with 25% to 30% down. If buyer wants non-recourse then lenders generally want 30 to 35% down at those cap rate levels.
More and more buyers seeing compressed yield in stand alone STNL buildings are going for these 2 to 4 top properties with national tenants in them. They still get passive and strong credit tenants but higher cap rates than STNL. Most clients I have do not want centers with a mix of mom and pop and then one national as you have more turnover although cap rate is higher. An exception would be an amazing location and if local tenants ever left you could easily back fill with national ones and raise the rents.
Retail is all I do day in and out.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
Joel - Ok, you think this Jack in Box deal is no good... Can you find a listing that is currently on Loopnet below $2m that you consider a better deal? I am curious...thanks
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
Hi Diane,
We look at Loopnet daily but mostly junk on there. I have a national database in the thousands for property management companies, developers, and other brokerages for internal or off market properties. My clients get first looks at the better properties. Generally what doesn't get action in 3 to 4 weeks gets put on Loopnet as a last resort by a brokerage or a seller.
Occasionally there is an overpriced seller that everyone forgets about and we call to see if they are motivated now. Nobody touches them because they do not know they have reduced to where it is now a good deal. We also sometimes run across a broker that has a limited network and will put something good on Loopnet. It happens but not as often. Since Loopnet and Costar merged their marketing expenses for a broker have gone through the roof so a lot of brokers avoid them all together and sell through other back channels.
I stay busy so I only work with investors who want to be a client one on one with me to locate the good properties.
It's best to go with one broker and then give them the chance to help you find the property you are looking for. If they are not getting it done then move on to another broker. You also have to be realistic for returns as well.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
I am looking to 1031 a rental property that has about $450K in equity... I have been researching both multifamily and commercial rental.... An ideal opportunity for me would be a NNN with no more than $500K down and no more than $1.5M in purchase price.... Do you know of any such opportunity?
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
I used to do more multifamily but it is overvalued in most markets today and is not passive ESPECIALLY at the 1,500,000 level.
Quality per door unit cost is about 75k a door or higher. That is only 20 unit property and is not passive. To get passive you need scale about 70 doors or more for full time repair person on staff and onsite property manager.
For the 1031 are you under contract for the property you are selling with a buyer yet? Once that closes you have 45 days to ID 3 selections with your 1031 company. The money has to go from your closing directly to the QI 1031 company and they hold it until the closing for your replacement property or properties.
What kind of initial cash on cash after your down payment are you looking for? 6,7% before the rental increases kick in?
- Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes9yWill banks not tell you what rates they can offer unless you present them with a DSCR and rent rolls? I would probably use a commercial mortgage broker but doubt I can find anything that's 80% LTV with a 30 year amortization in the 4.5-5 range...at least it felt that way today. Also...the COC return on these NNN properties...is it even double digits? I rather put my money in a mutual fund or REIT if I'm only going to get 8-9% on a CVS.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
I am familiar with 1031 procedures...I attended a couple of seminars on it last year...
With commercial, I see a lot of them are allowing rent increase of 8% every 5 years... I am hoping to get to a good balance between some cash flow AND minimal risk of current tenant not renewing the lease.... But no hard % that it has to hit, I am looking for a good package deal...
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9yWait... I do CVS and Walgreens deals all over the country and they are exceptionally good investments, long term leases, major corporate backing as far as tenant liability, totally hands-off, etc. My clients own a few hundred of them, in addition to other NNN and ground leased properties. You have almost no expenses. You pretty much kick back and collect a check, so if your purchase price is right, why would you not see a positive return? Lenders should be able to tell you what their rates would be assuming you meet their DSCR, occupancy and income thresholds. They won't issue a commitment until they have all of the documentation, but they should give you a pretty good estimate or at least a formula. Maybe some lenders on here can weigh in, but of course, depending on the condition and specifics of the property, the terms you are mentioning don't seem out of reach. I close loans with those terms all the time. I haven't closed a standard commercial loan over 5% in ages. 25-30 year am is the significant majority of what I have been seeing. 80% LTV is also pretty much the norm for all of my recent loan closings. I think I'm missing something here. Not sure what the disconnect is. Which lenders have you been speaking to?? Any commercial lenders on here that can provide some insight? I'm really curious now as well!
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
CVS and Walgreens typically have flat rent in the primary terms of the leases which run 20 to 25 years at a time.
As the years wind down on the primary term the amount down required tends to increase. Years and years ago when you had an 8 cap Walgreens with 14 years left on primary you could get in with in some instances 10% down.
Those days are pretty much gone as pharmacies are typically in the 5 to 6 cap range with any decent years left on the lease.
If you are paying all cash you can find a high cap deal like 8 or 9 cap and roll the dice that in 3 to 4 years the pharmacy picks up the option period. Those are generally 2 million to 5 million properties so you need lots of cash. In New York and other places they can go for 8,10,15 million.
With CVS you have to watch out for rent holidays at the end of the primary lease term.
There is NNN,NN, ground lease, leasehold, and zero cash flow properties with pharmacies.
Many times they are used as retirement vehicles and estate planning.
Diane buying a pharmacy on the 1,500,000 range is not likely to give you the quality location. Those tend to be in weak suburban to rural locations.
I usually do a consult with clients on the phone as it is too much to put on a forum topic. People think NNN is easy but it is passive once you select and buy the right property. Until that time there are a ton of variables you have to look out for.
- Rental Property Investor · Dallas, TX · Member since 2014 · 15 posts · 5 votes9yLess of a headache and longer leases.
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y10 year TERM, probably, not amortization. There is no way a 10'yr am is the best you can do on a decent property. No one could possibly afford to finance in that case. and I have never seen 40% down requirement. I'm closing 6 loans this week (god willing). 3 refi's, 1 LOC and 2 purchases and not one has the terms you are suggesting...I'm really confused.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
yes, 10 year term with 30 year amortization... but 35% down minimum... Call up CIBE, they are pretty big nation wide, and they will tell you any minute that 35% down minimum, and close to half of all transactions these days are all cash....
- Investor · Andover, MA · Member since 2015 · 269 posts · 67 votes9yVery interesting discussion folks!!
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9yOk, again, I am not going to engage in a back and forth, but half of all transactions are not closed in all cash. I am not familiar with CIBE, but I deal with tons of banks from local credit unions to the biggest international institutions on simple commercial loans to complex adjustable and swap transactions, so I have a pretty solid level of experience with commercial financing and 35% minimum down must mean either you or your property are not desirable to the lender for some reason. I most frequently see 20 or 25% if the property and the borrower's financials are in good shape. As to term, of course a lender isn't going to commit to a 30 yr term on a commercial property with so many variables that bear on income over the next 30 years, including the likelihood that you have no lease with a 30 yr term. That is extremely rare. 10 year term was never the concern that we were discussing, as far as I understood it. The amortization was the issue, and again, 25-30 is very standard and reasonable. Peter T. Would you be willing to share which banks you were having trouble finding that longer amortization calculation and the 80/20 with?
- Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes9y
@Diane G., if they're only quoting you 35% down then it might be your deal is not solid enough or your finances are not solid enough or it could just be CIBE. You'll probably get better terms from local or regional banks. Find a mortgage broker with good relationships to the bank in your area.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
CIRE is the listing agent on the deal, and we have not ever got to my financial yet, so the 35% is what they quote everyone, not just me.....
One thing I have noticed with this forum is that people say all kinds of things, but if you ask them to specifically give a better deal, or a better lender...... Silence....
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9yDiane G. It's hard to give you anything constructive to work with because you throw out random unsubstantiated facts, interchange concepts like amortization and term, you start talking about an irrelevant 1031 deal in the middle of a different thread, you mix up stats for residential and commercial sales and firmly assert them, you go from talking about CIBE being this well known lender to CIRE, which is the listing agent on a property? What does that have anything whatsoever to do with this topic? Why is a listing broker giving you loan terms? You are all over the place and make it difficult for anyone to provide useful answers. Plenty of people on here have tried to offer helpful responses, I'm not sure what you are looking for in terms of BP members finding you a solution to a problem we can't even seem to really concisely identify...
- Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes9yJessica Zolotorofe you keep talking about all the loans you are closing and favorable terms. Are these your own personal investments or a huge firm that you work for? Big difference between Joe Shmoe with 1m in real estate holdings getting terms on a CRE deal and Joe Shmoe Inc. a firm with 20 people and 75m AUM getting terms. I have also yet to see people offer COC return numbers on NNN. I spoke to Northfield Bank, New Millenium, Spencer Savings (********), Magyar Bank, etc. Nothing close to 5% or 30 year amt. It's why I started the thread. Even a 25 year amt really drops the COC return.
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y
I work for a medium sized firm, but I don't get the loan commitments. I only get the loans after my clients secure the terms. It can't only be a COC analysis, you have to also consider long-term upside for a lot of commercial real estate, especially in this market. Of course cashflow now is an important factor, too, but can't be the only one. I thought @Joel Owens provided some good insight as to your different types of NNN and the COC return above, but if not, he is a great resource in that regard. Where is the property you are trying to finance? I can't speak as to your net worth or the NOI of the building, so with very little detail, it's tough to say exactly, but most of the banks that I work with typically will turn down a loan that doesn't meet their criteria instead of just offering a higher rate and worse terms. Again, since I'm not sure exactly what we're dealing with, I can give you a few people to call depending on what state the property is in.
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9yJoel Owens can correct me if I have it wrong, but Peter T. as far as COC, I think it's a numbers game very specific to your situation, and not sure there is a general blanket response with regard to NNN. Even the same exact tenant the answer would vary, I would think. NNN leases can be for $200 or $200,000,000, Could be midway through a long-term lease term, or only have a few years left. Could have great rent escalations or not, you may have needed to provide some TI which will eat into your rate initially but provide higher rental income and longer term commitment from the tenant, or you could've walked into a fully operational property. You have no carry costs, so that helps as far as predictability of your monthly nut, but LTV percentage aside, I think it just depends how many dollars you actually invest versus how strong and reliable your lease is. So some NNN will be very high rates and quick recapture of your initial investment, others you may be able to find a gross lease or a NN that actually shows a better rate.
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