Why commercial over residential?
Peter TverdovBusiness Member
Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votesWhy commercial over residential?
Most Popular Reply
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
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
Hi Diane G.
This is a forum where in my free time I post information so that it can be read all the time.
I only have time to help clients with specific things you are asking about. I make 4 to 5 figures an hour for my time.
People will ask all of these things from you and then ( poof ) their gone. I only have so many minutes in the day.
Again if someone commits to me as a client then I will put my full resources and knowledge behind them to help them try to achieve what they want. If not I am not a charity................ : )
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
To the comment half of all properties are closed in all cash I could see that for sub 1,500,000 properties as there is a lot of 1031 money out there. I don't know about half but definitely a good amount of them.
When the price point starts going up 2,4,7,10 million etc. then the amount of all cash purchase percentages starts to go down more and more.
Anything sub 2 million has generally a lower cap rate because so many buyers are chasing buying something at that level. When you go to 3,4,5 million etc. the loan is larger so rate is a little better and the cap rate is higher as less buyers available to purchase. So you could get a 60 to 70 basis point swing or more with a larger loan and higher priced property. You are also putting more of your money down to do a larger deal.
- Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes9y
Originally posted by @Joel Owens:
Anything sub 2 million has generally a lower cap rate because so many buyers are chasing buying something at that level. When you go to 3,4,5 million etc. the loan is larger so rate is a little better and the cap rate is higher as less buyers available to purchase. So you could get a 60 to 70 basis point swing or more with a larger loan and higher priced property. You are also putting more of your money down to do a larger deal.
This is an interest point. Thanks for the insight.
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y
@Joel Owens the 50% of all deals is a residential personal home figure from a few years ago. It's not even true for residential anymore, let alone commercial. And like you said, depends on the category of real estate we are discussing, there being a major distinction as far as "cash deals" (even with 1031 money) on the much higher end purchases.
- Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes9y
WOW!!!! What an education on commercial real estate! If you want to learn more from experts go to the forum posts by @Jessica Zolotorofe and @Joel Owens and start reading all of their posts. What is the return on a NNN investment is not an easily answerable question.
My first investment property was mixed use so early on I saw the differences between commercial and residential. I went on to acquire both but have sold most of the residential and am reluctant to pick up anymore. Joel Owens had the best line on this page "I do not enjoy residential tenants on any level". Once a commercial property is stabilized, it is pretty much out of sight, out of mind. You are also dealing with business owners vs renters.
In terms of commercial, I have mostly been a value add investor. I find the buildings that have been neglected, bank owned or vacant. My loan terms are not the greatest because most banks won't compete for these types of properties. Years ago there was one local bank that took a chance on me and I have been loyal to them ever since. They will finance whatever I bring them because of their confidence in my ability to turn the property around. My last loan for a vacant water damaged office building was a 20 year am, 10 year term, 30% down @ 5%. Not the greatest and I can do better, but I believe building relationships is an asset. IRR for my value add deals have been between 27-196%. Those deals are much harder to come by today.
With all of the benefits of commercial noted above, the obvious downside is it can take longer to fill space. The market cycles are also different in that residential recovered way before commercial. So instead of joining the SFR rat race, I focused on commercial. Do your research and spend the hours reading the commercial forums. There is a ton of knowledge out there.
- Real Estate Lender and Broker · Dallas, TX · Member since 2013 · 966 posts · 500 votes9y
Originally posted by @Jessica Zolotorofe:
Joel 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.
Jessica,
When it comes to triple net investment grade tenants, the lease is the value. The building is secondary. For instance, a Walgreen's store will typically pay over market at the beginning of their leases, but over time, as they have no rent bumps, they are eventually paying under market. Walgreen's cap rates go up over time, as they have flat rents and tie up properties for long terms (75 years, typically 25 years firm with option) An investment like this is typically a legacy investment, where a wealthy investor passes the asset to his kids.
Another example, an investment grade tenant put a clause into a lease stating the developer and future owners were obligated to maintain the parking lot to a higher than normal standard. The tenant had the right to re-do the parking lot and with hold and equal amount of rent. A clause like this detracts from value as the tenant could re-do the parking lot every year if they wanted to.
I have also seen investment grade tenants merge with other companies. If Walgreen's is listed as the guarantor on a property, and they become Walgreen's Boots, is that guarantee worth anything?
Mark
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
For anyone interested I have a development site I was proposing to Walgreen's but at this time their expansion plans in many states are on hold.
I talked to Walgreens and they are expecting a decision with the FTC commission end of January on the buyout of Rite Aid's.
Walgreen's doesn't want to add new locations until they know Rite Aid will go through or not as they will likely shut down some Rite Aid's or Walgreens that are older or in sub-optimal locations too close by.
Recently in the last few weeks it came out in a news story that Walgreens if Rite Aid purchase is approved will spin off about 800+ Rite Aid's and sell those to Fred's.
Fred's is a pharmacy concept that goes in weak suburban to rural towns with low demo's. By selling the Rite Aid's that Walgreen's doesn't want anyways they are bolstering the position to the FTC that they will not create a monopoly with the approval of the acquisition.
Will have to wait and see if the FTC goes for it.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
COC numbers is specific to debt that can be placed on a property and the borrower.
I usually do a phone call with a client to talk about percentages, types of properties, etc.
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y
Good morning @Mark Creason. You are right about the pharmacy tenants, but as you mentioned, you also have to consider when you are coming into a lease. If you build a Walgreens, yes, you're building it to either flip, or to hold onto for your kids and grandkids, with a little monthly money coming in to play with, but it is a long-term, passive type of investment for sure. I actually just did a Walgreens that had a 75 year term instead of the 25+extensions they typically did in the past. Now they take the whole 75 and have points during the term where they have the right to cancel, which is a little bit weird, but I guess effectively the risk is the same as if they were true extension options.
We do often get gross sales rent from pharmacies (CVS less so than Rite Aid and Walgreens these days), which may help offset the lower market rent. It's always a matter of your end goals, if you want immediate cash flow and less up front investment, then @Ash Patel has the right idea. If you want long term, hands-off investments, then there is a major benefit to the comfort of a tenant improving your land with a building or extensively fitting out a space so that their financial commitment almost ensures that they're there for the long run. Some of the Wawa, Quickchek type leases are doing a little bit of a shorter term 15-20, but quite a number of options. The last one I did was 6 periods of 5 years each, which I thought was more than I've seen in the past. Could have just been that location, but it does seem to be a trend.
As to your comment about the parking lot, also totally on point. That's why it is of huge importance when you are developing a commercial portfolio to have a lawyer or an abstracting company read every word and punctuation mark in the leases you will be inheriting so you aren't surprised by any of those things. A true NNN should not have any parking lot obligation at all, but it certainly does happen. There are also the leases that are called right on their faces "NNN or NN" and then if you actually read through, they are neither and the landlord will have some things to be bothered with.
With regard to mergers, it happens all the time, but the guaranties are still good. Whatever entity ends up with the original guarantor's assets (any successors or assigns) is on the hook. Walgreens Co. became Walgreens Eastern Co. at some point, the Duane Reade entities were rolled into Walgreens, CVS took over Hook-SuperX, LLC and Eckerd Corp., which then became Holiday CVS, LLC, and on and on. The companies are still around, so guaranties have not been an issue, at least in my experience, but maybe I have just been lucky!
And speaking of.... I'm going to hear a whole lot of frantic yelling clients pretty soon if I don't get back to work :) Clock is ticking to get deals on the books for 2016! Have a good day everyone.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes9y
Why?
Because everyone is different. Some people have giant balance sheets with a lot of debt. Others have giant balance sheets with little or no debt. Some people have high ROE requirements and don't mind the high time component that goes with these types of investments. Some people have a lot of cash and don't care to make it and them work so hard. Some people are chasing yield and others are chasing safety. Some people have little tiny balance sheets and value the return relative to the risk because their downside is limited.
Ray Alcorn has a great article about this. Google "Calculating YOUR cap rate + Ray Alcorn" or visit this link:
Cap Rate Formula | What Is Cap Rate?
What matters is YOUR ability to obtain financing and what YOUR return on equity numbers are. You can't compare what your numbers are to what the next person's numbers look like. You have unique risk/return, balance sheet, liquidity, horizon, and many other factor numbers.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
I am at a point where I just started to research into MFH and commercial... I have a refi that i need to work out first, and another personal issue as well... Both of which are expected to resolve by June/July time frame....Until then, I am just gathering knowledge on MFH and commercial...
I will watch the CIBR website and see how long it takes to this JIB opportunity to sell... they also have starbucks at $2.7m, and i will see how long that one lasts.... Will be interesting to see...
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
While I am sure you are a very good person, I get the impression that you focus on petty stuff and go into argument mode...It happened with the whole TIC thread and now this one again....
That is really not what I am looking for...I welcome your inputs, but please focus on bigger picture....thanks
- 9yAlvin MercerPro MemberMarietta, GA · Member since 2016 · 26 posts · 12 votes
Very Good Info @Joel Owens and @Jessica Zolotorofe. I'm in the process of acquiring my first commercial deal here in Georgia. So here's my story. I bought a business.(all the assets, name, etc.) In addition to getting the business I got a 2 year option on the property in which the business is located. The property is a 5 suite strip mall in which 1 of the 5 suites is the business I run. Three of the other 4 suites are rented for a total of about $4000 per month. My rent is an additional $2500 per month. So the total income on the property currently including my business is approx $6500. Tax assessed value on the property is currently about $850K. Taxes are abot $13K per year. I have a 2 year option on the property for $775K. The sweet part of the deal is that my option includes an adjacent parcel of land with a current tax assessed value of about $350K. What would be the best way to go about getting this deal financed? My goal here is to acquire the real estate and free up as much cashflow as possible through having just one loan. Additional info pertaining to this deal is that I currently have an equipment loan for my business that I pay about $5500 per month. Balance on that loan is about $225K with about 4 years remaining. Ideally I'd want to cash out some equity to pay off the equipment. Leaving me with just the mortgage on the building. I'd essentially free up $8000 (40%of my gross revenue in the business) plus I'd gain the rents from the other suites ($4000+) Any feedback, suggestions, ideas, etc. would be helpful. Thanks.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
You need to assess highest and best use for the parcel of land included in the option. The land might have a little or a lot of value depending on what the research shows.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
Diane G
There are some books on Amazon for commercial and triple net investing. Additionally you might want to visit with your local real estate investors association.
Your timeline if all goes to your plan is a half year away. So much can change with cap rates and interest rates in the market over time that looking that far into the future for what is selling today will have minimal impact. If you were 1 or 2 months away it might be different.
- Real Estate Lender and Broker · Dallas, TX · Member since 2013 · 966 posts · 500 votes9y
Jessica,
As a lender, I am always checking leases for potential catches. It is usually one of the first steps we go through, as sometimes there are clauses that maybe legal, but not landlord friendly.
I have seen government tenants ask for appropriation clauses. If a landlord doesn't no any better, he can lose value by allowing that clause. The clause could shrink the firm term of the lease. I recently saw a Social Security Administration property that has a 60 day kick out clause. A lender would not offer great financing terms (non-recourse, high leverage, etc) with such a clause.
I do enjoy your perspective on these issues.
Mark
- Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes9y
@Diane G., I think you need to be more respectful of the time and input these experts are giving to you. I have mentored people over the years and like most mentors, I will match my time to people's efforts. If someone will do the self-study/research that I ask, I will give them my all. For each person willing to put the effort in, there are dozens who want to be players but don't want to grind.
I get that you want to educate yourself, but put in the grind and spend days reading the commercial forums. This way you can ask the type of questions that justify people spending time on a response. Don't forget this is a networking opportunity, you don't want to insult people that are willing to help you.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
Not sure where you see the "insult"... If you are referring to my comment on the "petty debate", I am willing to stand behind my comment about getting into an argument over petty things such as a certain terminology, or a typo, or my user name.... That is not helping anybody no matter how good intention is....
- RIchland, WA · Member since 2016 · 4 posts · 1 vote9y
The question is what you rather own? knowing what you like best is the ideal way to determine the best property type for you to own and invest in. I recommend that most of my clients look into RE in industries they are familiar with before making å purchase decision. Also, not all commercial real estate is created equal and if you purchase something in an industry you do not understand there is a huge change you can lose money.
I would recommend that you work with a commercial mortgage broker who can guide you and select the best possible loan, terms and conditions for your capital needs.
Jhoanna R. Jones
- Real Estate Lender and Broker · Dallas, TX · Member since 2013 · 966 posts · 500 votes9y
Originally posted by @Jhoanna Jones:
The question is what you rather own? knowing what you like best is the ideal way to determine the best property type for you to own and invest in. I recommend that most of my clients look into RE in industries they are familiar with before making å purchase decision. Also, not all commercial real estate is created equal and if you purchase something in an industry you do not understand there is a huge change you can lose money.
I would recommend that you work with a commercial mortgage broker who can guide you and select the best possible loan, terms and conditions for your capital needs.
Jhoanna R. Jones
Jhoanna,
I agree with your post.
With commercial real estate, value is in the lease. The lease(s) will determine financing and potential exit cap rates. Too many people don't understand leases which can include exit clauses, gross or net terms, and other contingencies that can detract from value.
Mark
- Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes9y
I have been eye balling an off market multi unit building. There are two street level store front suites, and 6 residential apartments units above.
The property is in disrepair, and honestly I am not sure the last time there were residents living in it.
If I can get the owner to agree to a small down payment and have the owner hold the paper, while I use the rest of the money to get it rehabbed and rented, what type of commercial loan would I need after that to service it?
Also there are zero comps for this, so would the appraiser use an income approach to determine the value?
If the appraiser finds that the property is worth 800k. How much would a commercial bank lend up to?
Thank you
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y
Hi @Rich Hupper. I'll send you a private message in a little.
- Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes9y
Originally posted by @Diane G.:
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....
We say things but you don't like to listen. You get loan terms from a listing agent? That's what you base things on? And they don't know squat about your financials? I'm going to test the 'ignore poster' feature...
- Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes9y
@Rich Hupper - My first property was mixed use and the first floor commercial was on a long term lease. I had several bank presidents from smaller banks tell me that they were not interested in financing it. It could have been that it was in a college town or that it was 120 years old. These are tough to find comps on, have appraised and find financing. Explain that to the seller and convince him to carry part of the note.
In my case, value add deals are financed at 70% LTV.
- Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes9y
@Jessica Zolotorofe Thank you
@Ash Patel This would be a great building to own. It is down the street from the city's main drag and business area. The apartments would rent quickly too. The building was built in the 1800's. Should my offer be subject to the town permitting two businesses and six residential homes? Or should I worry about getting the permits after I have title?
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