Commercial or Residential?

Question

Hey everyone I've got a question!

My business partner and I are having a slight disagreement about what to jump into first. We have access to a $250,000 HELOC and $65,000 cash on hand we are willing to invest.

I have owned two residential rentals in the past and have managed them both myself, I am at a point in my life where I do not want to do that again.

Our first deal together will be her first deal.

We have both been studying real estate investing all year long and plan on pushing for our first deal as of January next year so our finances will be aligned.

I am leaning more towards a quad plex minimum or to even attempt to push into commercial size rentals instead or even try and find a small strip mall since I've read multiple places that commercial is a lot more beneficial and it's easier to manage businesses rather than tenants (but with the right property management I suppose neither of those points matter)

She would rather start smaller, still multifamily but a duplex or triplex max due to simplicity and to get our feet wet first.

All in all I'm not too worried about starting smaller BUT would like to see what you guys would do if you had the same finance options that we do.

I'd appreciate any advice or feedback! Just wanna see what your thoughts are! Thanks a ton!

-Scott

Matt M. · Answer

@Scott Brewster

Unless I found a really really good deal, I’d be staying far away from commercial these days with covid and businesses going out.

Mike Dymski · Answer

They both can be profitable strategies; so, I don't think we can help you (aside from bias that everyone has for their own strategy).  Maybe you should go your separate ways (of if she is your boots on the ground, you don't have a choice).  Picking the asset class is supposed to be the easy part.

Israel Garavito · Answer

@Scott Brewster congrats on wanting to make the jump into commercial. you’ll find that the larger assets mat be easier to manage than the smaller ones, since you can have a PM in place.

With 250K you could buy between 10-15 units in a light value-add deal (c/c+).  I’d personally look for a property where I could use 50 of those 65k to do a light renovation and improve management. Think loss-to-lease reduction/elimination, and light renovations (paint, lighting in common areas, maybe carpet in some units, new faucets and new outlets all around, etc.  no more than 2-3k/unit).   I’d leave the other 15 - 20 for legal and reserves.

But first, make sure you network and meet with potential lenders.  Go to your local or regional banks and meet the commercial lenders.  Commercial is all about relationships and it may take a while for one to say “ok”.  Have a PM already in place (interview many), and see if you can get ore approved for a certain amount.  Then go hunt for a deal.

250k  is around 14 units@ 50k/door.  Assuming an 800/month rent or so and using the 50% rule, you are looking at an approximate net annual income (with a 4.5% 460k note) of around 30-35k, prob tax free due to depreciation.

Not sure what your market is like but that would be my thought process going in.

Scott Brewster · Answer

@Mike Dymski She IS my boots on ground haha. It's not that we're having a big argument about it, it's just that we're both at different points in our lives and have different levels of risk we're willing to take! I suppose you're correct about the asset class being the easy part, I just know we're starting with a lot more than most do and don't want to be spinning our tires in duplexes if we could realistically be getting 8 plexes for about the same work is all.

Scott Brewster · Answer

@Simon W. What do you mean by that?? I'm curious to all options!

Account Closed Thank you! I haven't considered the AZ market yet but I will keep you in mind if we want to push that far south. Trying to see what's around us first! (Eastern WA).

@Israel Garavito Thank you a ton for this break down! That's definitely an awesome breakdown I was hoping for. Commercial is fascinating to me and it makes me nervous but in a good way. The one draw back I have atm is that I'm currently living in the middle east. I think my business partner will do great at forming relationships back home but I wish I could be there to do it as well. But I most likely wont be able to get the loan if I moved home. I appreciate that great write up! It helped a ton. I'll probably shoot for an 8plex if possible. Idk if I want to use up my entire HELOC on the first deal BUT it's there and we're both willing to work for it!

William Jenkins · Answer

Just saying invest in commercial is painting with a very broad brush.  There is industrial, office, and retail just to name a few.  Each of these sub sectors has its own pros/cons and supply/demand drivers.  Leases from one to the other are very different as well.

Eveyone has the impression that managing commercial is easier than residential.  That can certainly be the case for large national tenant NNN properties, but with your budget and likely yield requirements you will be looking at small time commercial opportunities (i.e. small strip centers).

Some generalizations for what its worth.... Residential is generally much easier to lease and minimize vacancy.  Residential tenants come and go, but there is usually another one right around the corner.  With commercial unless you have an extremely in demand commercial property, you will have to work much harder to attract tenants and vacancy in between tenants will be much higher.  Finding the right fit tenant is harder in commercial, but the leases are longer term, and renewal more sticky than in residential.

In general I find my commercial properties to be very time consuming during vacancies, but otherwise easy to systematize manage once tenants are in place and things are normalized.  My residential properties seem to demand more constant attention but the necessary time requirements seem lower during the peaks and more constantly spread out.

If you are looking for commercial (especially strip centers) I would wait for a deal.  I think you could see a lot of distress in that sector in the near future, and I would not be paying up to assume other peoples problem leases.

Jon Kelly · Answer

@Scott Brewster One of the beauties of real estate is there are so many strategies that can work. Is there any way you can look for both (2-4 units or 5+?

Depending on your market, there may not be too many 5+ properties available. So, why not look for both?

Maybe instead of # of units or residential vs. commercial, you change your criteria to "$200/unit in cash flow" or 12%+ cash-on-cash return. Then, focus on properties meeting your new criteria regardless of # of units.

Scott Brewster · Answer

@Jeannette Henderson I definitely will! It looks like we’re going to try and push at least to mid size multi family. I mean, if a killer deal comes up for a duplex of course I’m not going to pass up on it BUT I’d ideally like to shoot higher. If we can grab a 4-8plex we’re jumping :)

Jeannette Henderson · Answer

Please update the thread and let us know what you decided to do. I had the same issue going on with my boyfriend. I wanted to fix and flip a foreclosed 4 unit, and then use my VA loan to purchase it as the 1st deal. My boyfriend said do a SFH flip first. He is older, want to slow down, I am younger, want to go all in lol...He wants what he perceives as less risk and I want what I perceive to be better outcome for same amount of work/risk (its all a risk, either one in my eyes)... As of now, I agreed to the SFH...but this reignited my original thoughts on the matter.

Scott Brewster · Answer

@Simon W. If you're talking like the small shops on the ground floor and residential living on the top floor I was just talking about that today. I'm just not sure how many of those are in my market. Going to have to do some research!

@Matt M. you're right and I do live in a very democratic state. Now it comes to the issue of following the investors rules of "buy when everyone hates it, sell when everyone loves it"

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