4-Plex or more for inexperienced investor?

Question

Hi there

I am wondering if it is advisable for an inexperienced investor to get started with 5+ units or if it would be better to first stick to 1 to 4 units. I already know the process to get a conventional or HM loan, but never got a commercial one. In addition I will do this out of state and while working a full time job. Is getting a commercial loan too hard in such a situation?

Thanks

James Kojo · Answer

I probably  should have put emphasis on the word "directly" in my statement: You can't directly capture forced appreciation in residential the way you can with commercial. Of course you're correct in saying that there are many value-add improvements you can do with residential which improve rents.

However, when commercial property is evaluated and underwritten, it's primarily evaluated by the numbers (NOI/Cap-rate), where as residential is valued via "comps", which is a lot more nebulous. So if you raise rents by $100/month on an 8-cap commercial building, you have now directly forced appreciation by (100*12)/.08 = $15,000, whereas on a residential, it depends a lot on what your neighbors last sold their properties for.

Of course, nothing ever works out that precisely in the real world, as caps also fluctuate, but caps are not as volatile as comps. Still, hopefully my example and explanation illustrates the concept.

Hope that helps!

James

Chris Connery · Answer

I don't see any reason you would have a hard time getting a commercial loan. I think they carry a stigma that is way overblown. If you have the 25% down payment, a job, a property that you can prove cash flows. I think you'll be fine.

James Kojo · Answer

There's nothing especially "hard" about getting a commercial loan. I'm going through the process right now, actually.

The hardest part is finding the lender. For small stuff, you're dealing almost exclusively with local banks, so you either need to find a local broker who knows who will deals with OOS investors, or you need to get on the phone and start calling the banks directly. You can get referrals from your in-state network, or agents, or even here on BP. After you find one and establish credibility, then it's very similar: credit checks, appraisals, etc.

The big difference is that you can (must?) use an LLC for commercial, whereas you can't with residential.

If you can find a deal that pencils out with 4 units and another one that pencils out with 6 units, I would be more inclined to start with the 4. Residential class is just a lot easier to do the financing and the insuring, and you're not getting much more scale at 6 units.

The downside is that you won't be able to directly capture any forced-appreciation on residential class (4 units and below.) LMK if you need me to clarify that point.

That all said, there's certainly nothing wrong with starting bigger. Real economies of scale are realized at 75+ units.

Hope that helps!

James

James Kojo · Answer

@Ray Harrell : getting to 75 units is easy: start with 150 units in a F-class neighborhood, then wait a year.

At the end of the year, you should have only 75 habitable units left! :)

Jokes aside, I probably should have been more clear: I'm not suggesting anyone jump straight into a 75 unit. The point I was trying to illustrate is that the difference in economies of scale between a 4-unit and a 6-unit is not that great. The real inflection point comes at around 75 at which point it makes financial sense to hire on-site property management. The economy of scale for 4 vs 6 unit is realized primarily in the exterior paint and roof costs per door, which admittedly may be significant, but probably not a deciding factor.

Hope that helps!

James

Matt K. · Answer

depending on where you're looking.... you might find it extremely hard to get a deal on commercial side. You're going to have lots of competition and if you have no history/relationship in those markets with anyone you're going to get leftovers.

Brian Garrett · Answer

@James Kojo Curious why you say you cannot capture any forced appreciation on 4plex or smaller? There are lots of ways you can force immediate appreciation on residential MFR's.

Simon Stahl · Answer

Thanks you @James Kojo, that helps a lot.

@Ray Harrell Using other peoples money or by starting with what you can afford and adding units or trading up over time I would say.

Ray Harrell · Answer

75+ units you can quit that F/T job!!! How can a small guy get into properties that big without millions of dollars saved up?

4-Plex or more for inexperienced investor?

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