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
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y
@Rich Hupper My vote is definitely approvals contingency! Makes a huge difference in what you should be willing to spend.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
From the 1800's look at unapproved additions over time, and grandfathered items that have expired with current zoning once ownership changes hands. The current vacant set up of the property might not even be allowed if you wanted to rehab it affecting your projected returns.
There have been investors on here buy a 4 unit only to find out the city or county will not allow it so now they have a legal 2 or 3 unit and their whole cash flow model and future value of the property has changed.
Sometimes people buy the current ownership LLC itself so that the property does not show changing hands for property taxes to increase. That strategy can have challenges of it's own. Best is to have legal counsel look at the situation and advise as to multiple options and you decide how to proceed.
Property could end up being a money pit if not bought right. If you do owner finance make sure you get non-recourse on the note so if it does become a money pit you can deed it back to the original owner and have minimal losses.
If they want you to pay an inflated price, recourse on the loan, and short term balloon note with higher than market interest rate you might just want to walk away. Even with owner finance you still have to buy right.
No legal advice given.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
Apparently there are things that you dont know about in this world.... The RE broker told me min 35% down regardless personal financials... if not strong, higher than 35%.... hard to imagine? that is because there are things you dont know about....
Feel free to use "ignore" button, and you dont have to tell me before using it.... Just go do it.....
- Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes9y
@Rich Hupper, Here is how I would handle this deal: If you can get the seller to hold the note, lock it up under contract with a 45 day contingency period. Negotiate the best that you can but know that the final number is yet to come. Discuss your plans with zoning and the building dept. Tell them the great things you will do with the building and get their feedback. Have the fire dept do a complete inspection. Pay for individual trades people to do inspections (Plumber, Electrician, Roofer, Pest Control, HVAC, Structural).
When you compile the list of deficiencies, back to the negotiating table. By this time, the seller may be emotionally attached to closing the deal. Remind them that unless it is an as-is closing, they will have to disclose any major defects with the building.
Buildings from that era are often over engineered, very solid and obviously stood the test of time. You want to avoid moving or even opening any walls because nothing good will come out of that. Keep in touch with me, I would be happy to help you through all of the nuances I learned the hard way.
- Investor · Coppell, TX · Member since 2008 · 2k+ posts · 646 votes9y
Hello and welcome to BP! I do not have much exerience I will attempt to answer your question. One thing that comes to my brain is that commercial projects are risky and have typical clause in them that could effect value. Commercial properties tend to be harder to come up with market value because they are typically unique. Commercial properties have less competition than residential properties. Plus, the commercial properties are more complicated than residential properties, typically. Commercial loans typically require a larger down payment and lesser time to pay off. The location is usually more important on commercial properties.
I hope this helps you at least a little the bit. Good luck to you!
- Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes9y
Thank you @Ash Patel @Joel Owens @Jessica Zolotorofe
Sounds like the town will play a big roll in determining the value of this property. Its hard to put a number on this unless I use the 1% rule. If I can get 1200 per residential unit and 2000 for each commercial unit the 1% rule says the value of the property is 1.1 million all fixed up and fully operational.
The town has it assessed at 404k.
Fair market value must be less than the assessed because it is not income producing right now.
If I can get the owner to hold the paper on a non recourse loan with a long amortization period so the property will cash flow, and no balloon, it wouldn't make sense to find a commercial loan correct?
- Attorney · NJ · Member since 2016 · 1k+ posts · 794 votes9y
Correct. If you can get the owner to hold paper until the property is fully improved and you have income, you can refinance with a commercial lender, probably at a better rate. But I don't see many commercial lenders touching this right now unless you were a very seasoned developer with a portfolio and some significant net worth.
The property assessment may have an equalization ratio you have to apply, so double check on that, but FMV should already take into consideration that it is not income producing and its current condition, so I don't know how often that town reassesses or how accurate their tax assessments are, but assuming that they are done properly, they should reflect the value of the property as it stands now.
Offer a price that you would be comfortable paying assuming the property is approved for your desired use. Check comps in other towns if you can't find comps right in the area, or check loopnet for unimproved land costs and extrapolate. There have to be some properties that you can at least get an idea from. Factor out your cost to actually apply for and obtain permits (engineer, architect, lawyer, etc.), plus your construction costs to get the building to the condition that you need for your intended purposes, and then just make sure you put the contingency in the contract. If you can't get your approvals, before you terminate, see if you can renegotiate the price.
- Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes9y
Originally posted by @Diane G.:
Apparently there are things that you dont know about in this world.... The RE broker told me min 35% down regardless personal financials... if not strong, higher than 35%.... hard to imagine? that is because there are things you dont know about....
Feel free to use "ignore" button, and you dont have to tell me before using it.... Just go do it.....
FWIW a commercial mortgage broker (that is apparently one of the biggest and best in the US) told me the same "minimum 35% down" BS. I spoke to a bank yesterday who mentioned 25% down and were pretty investor friendly.
- CA · Member since 2016 · 1k+ posts · 1k+ votes9y
Ha... that is interesting to know... Thanks...
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
Mortgage brokers generally want to be conservative. That way you are not buying a property based on some exceptional rate that may never happen. Instead they say let's look at it with 35% down and does it work for you the return and down payment?
If yes then they might can beat the initial quote with less down.
Speaking to a bank doesn't mean anything. They will tell you anything on the phone or in person. Banks re-trade stuff all the time and usually you are talking to a grunt that doesn't make the loan decisions and are talking in generalities. Usually I like to talk to the vice president or the president of the bank. Unless the bank has reviewed the property, due diligence materials, your financials, and has given a loan commitment with a rate lock in writing you have SQUAT.
They can promise you the moon and get half way into the deal when you have sunk costs and re-trade you. You then have to look at eating those costs as the bank will make appraisal,etc. in their name with the lender deposit even though you paid for it. They do this to keep buyers from "loan hopping" to someone else.
Now when you get a different loan rate mid deal you might have to get the seller to extend your purchase contract or lose your EM if you can't close in time. Another alternative is to take the re-traded loan rate and close versus starting all over again with another lender and losing the lender deposit. Also you will have lost money for reports you have paid so far and mounting commercial attorney fees to unwind the deal.
I have talked to hundreds of lenders over the years. Although I am not a commercial mortgage broker I understand the process pretty well. Just remember until you have a rate lock in writing from a credible lender you have nothing but hot air from them. That is why I always laugh when banks give some teaser rate to engage a buyer to start the process with them but say the rate is not locked until days before closing. I then say what will the rate be then? They say we have no clue. Exactly. You have nothing. In that instance you would need to underwrite the deal as bank is saying 4.5 today but project rates rise to 4.8 by the time you close in 45 days and see if it still pencils.
Don't do a deal based on everything going perfectly in a purchase or you are setting yourself up for disappointment.
- Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes9y
Joel is spot on. There are certainly some exceptions, like when you have history with a lender. With small banks you get to know the decision makers and can have more confidence in some of their
verbal summaries. You know, too, what level decisions are made so that (for instance) planning for a $1.5M deal is different than a $650K deal. And you know when to push for leverage or not, and if they will trade other collateral for leverage. Read and understand the lender's SEC filings since they often outline commercial lending criteria and sometimes hint at areas of asset concentration concerns.My rule of thumb (yours will be different) is that if the deal I am looking at is $X, then I allocate X/$100K months in preparation. I've got a $650K commercial deal in process now at 80%. I started prepping about 6 months ago, so I feel right on target.
- Rental Property Investor · Orlando, FL · Member since 2015 · 131 posts · 62 votes9y
I'm just starting to meet with a few commercial players out here in Orlando and from what I'm hearing it really is something to look into. In my opinion, if you do it correctly, there seems to be less risk compared to multi-family.
My question is based on finding the value in land or shell. With a SFH or multi-family, you can throw together a pro-forma and find out whether or not it's going to be a deal. I'm assuming commercial isn't that easy? If it is, what should I be looking at when trying to understand the value of a plot of land or shell? - Podcaster & Multi-Family Apartment Investor · Denver, CO · Member since 2016 · 273 posts · 138 votes9yDiane G. I know of a 24 unit that seems to fit your model pretty well. The cash down is 150k and the NOI is 50k It's got an 10 cap and it's in a B neighborhood. I'm not wholesaling it or asking for a commission or anything. Just saw your criteria and thought I'd let you know.
- 9yAlvin MercerPro MemberMarietta, GA · Member since 2016 · 26 posts · 12 votes
@Joel Owens- How do you assess the highest and best use. Some ideas I have based on the location and traffic count include an RV Park or Self Storage.
- Investor · Fishers, IN · Member since 2012 · 520 posts · 499 votes9y
I ditched all of my single family rentals (about 100) for Apartments (about 400), then ditched all those for Self-Storage.
Bottom line is this - the Cap Rate!
If I buy a commercial property, and I lease up some vacant space, at say, $1,000/mo (use any $ you want) that brings a $12,000 annual increase to the bottom line (before any costs to lease it)
Using an 8% Cap Rate, I have increased the value of the property by $150,000 ($12,000 / .08)
Then, any TOTAL returns need to be calculated dependent upon any rehab costs to that individual space, as wall as any incremental operating expenses.
Thus, the reason I love Self-Storage - $0 Rehab to the unit - it's a metal box on a concrete slab, and $0 incremental operating costs - I'm already paying insurance, taxes, management, and overall maintenance on the property.
with any residential, or even commercial habitational, apartments - you have incremental costs of rehabbing the unit, repairs, maintenance (carpet, paint, plumbing, etc. )
That's why I dumped all the rest in favor of Storage, but for purposes of this thread, focus on the value created from a cap rate perspective, in lieu of an appraised value after rehab. You're ALWAYS capped by the highest value in the neighborhood. but with commercial, there is no limit! doesn't matter the size, nor overall condition (relatively speaking) the value is based upon the NOI, and applying a market cap rate.
Good Luck!
P.S. - Ignore all the fodder above from the other chuckleheads on BP and their Brokers regarding the minimum % of down payment for commercial loans - we're finding 10% down programs with the SBA, and all types of credit unions and community banks offering 20-25% down loans on commercial deals with strong upside and solid borrowers.
Stay positive, ignore the naysayers, and surge forward Peter.
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