Commercial vs Residential

[James Wise]

Commercial vs Residential

When I started out buying real estate I started out the same way many other new investors do. Low capital and no 1st hand investment experience. 

Naturally I started small, I started out buying cheap houses then as my skill set increased and subsequently my bank account grew I moved onto nicer houses and bigger multifamily buildings etc...

Currently at this stage of my investment career buying houses doesn't excite me much anymore. I am pretty focused on purchasing large multifamily buildings and commercial assets; Retail, Mixed use, Industrial etc...

Don't get me wrong I have bought and sold hundreds of homes. Holton-Wise is still selling a ton of houses so houses still excite me, I just don't really care to buy them as rentals at this point in my career which is what brings me to the point of this post.

One theory is that the even though commercial (retail/office) rentals have much longer periods of vacancy they should over the long term, net out higher returns than residential rentals.

However a common theme I have seen in many of the clientele that is serviced by Holton-Wise is that they shy away from commercial (retail/office) as they are afraid of the long vacancy period bankrupting them. Admittedly that is one factor that kept me away for awhile as a unit sitting vacant for 12-24 months is not much fun. However after my risk tolerance grew and my business got to the point where I could weather the storm of an extended vacancy period I realized that I like the commercial (retail/office) side much better and over the long haul the commercial (retail/office) units seem to have fewer months of lost rent then their residential counterparts.

Let's look at a hypothetical 10 year hold period.

Scenario A: You own a commercial space and it sits empty for 24 months. A new tenant is placed and stays for 8 years.

Scenario B: You own a multi unit residential space. The tenants stay for an average of 18 months. It takes you an average of 2 months to renovate & re-rent the unit every time. That is 14 empty months. (7 tenants) However if the property is being managed by a property manager that is an additional 7 leasing fees. which takes us to 21 months of vacancy. 

Factor in the cost of 7 renovations over that same time period & I the commercial asset performs better over that 10 year hold period even though the commercial property owner was hurting bad for those 1st two years. 

Here is the other theory. What if it took four years to re-rent the commercial (retail/office) units? Five years? Six years? The entire 10 year term? There are many areas of the country where commercial (retail/office) buildings have been converted into living space as there is a more tenants looking for housing then those looking for space for their businesses. We have seen a lot of that in downtown Cleveland over the last few years.

• What have you bought in the past? Why?
• What do you like to buy more? Why?
• Do you plan to change your buying strategy as your career (& bank account) progresses?
• Do you like the liquidity of homes as you can sell them a larger pool of buyers when you are ready to cash out?
• Do you buy homes for the 30 year financing terms?
• Do you buy commercial property for the seemingly unlimited amount of financing available?

[Joel Owens]

All I do is commercial. Mostly all retail these days. I enjoy it much more than residential or multifamily. Did that already and not my cup of tea.

Commercial vacancy for 2 years etc. is generally a fear based response from investors from other asset classes on the outside looking in. If an investor is in the retail space day in and out this is usually not the case if you have the right location for a property. Location for retail is critical.

If you have a mid line center between commercial nodes it will be harder to rent at lower rent per sq ft with mostly mom and pop tenants. Those cycle out more frequently than the national chains and large regional concepts.

Most retail center spaces are 2,000 sq ft and under with some at 5,000 and under. It's the junior to large boxes 10,000 sq ft and up that can sit vacant for a few years. Those type of larger tenants take a long time to commit to a new space or move a store from another location. The large spaces sometimes you can cut them up and fill faster. The smaller spaces have more available tenants for them.

Commercial has more upside but you need more cash to play. Saturation level in a market is important for retail. If you drove around and lots of buildings are at 50% occupancy then likely the area is overbuilt and demand is not there for the supply. In those cases you need the best location at the cheaper rents to fill your first ahead of the competition and get to 85 to 90% occupancy levels.

People think retail is set it and forget it but there are a lot of factors that go into buying or developing one before you get to the passive part of the national or regional tenant paying like clockwork every month.

I tell my clients to expect months of diligent dedication with forms, documents, due diligence, and some post closing items to get going. Put the hard work in on the front end to have a high quality mostly passive asset on the back end.