Multi-family on top of new medical office?

Question

Hi everyone. New here, first post! I have some experience with single family rentals but now considering a commercial real estate opportunity and hope to get some expert input.

I'm under contract for some land on which I will build new medical/dental office (my wife will occupy half). We are planning to build some extra leasable space for another professional tenant TBD.

Here's the opportunity we are considering: Zoning allows for multi-family apartments “second floor and above.” Given current planned size of the first floor, we could add 10-12 units on a second floor. The location seems great for apartments (apartment complex next door is at capacity) and there is growth all around. Does this idea make sense? What is the best method/tools to assess/analyze this opportunity? The total project cost would be at least 2X what we were planning to spend for the first floor medical space (but less on a $/sf basis), so do we continue to try and finance ourselves or is this a deal ripe for a partner?

Simmy Ahluwalia · Answer

@Ryan Schaefer - sounds like you have a good project in place.  Here is my $.02:  I don't know where you are located or the size of the parcel of land, but this is what I would do:

1.  If the land is big enough to accommodate both your wife's MOB and a separate, independent apartment complex, I would offer the following:

a.  Leverage SBA (owner occupied at 51%+) for the construction of just the Office piece.

b.  Create separate plans for an apartment complex next door to the office complex.

Keith Loranger · Answer

Make sure you have the building systems designed to properly track and account for residential and commercial tenant expenses.  Many developers, even more experienced ones, sometimes don't approach designing and building their properties with the operational plan in place first.

Evan Polaski · Answer

@Ryan Schaefer

I always look at the long term goals, first.  Do you want to own multi-family?  Management of MF is vastly different than commercial space. And even with PMs, with only 10-12 units, you are likely working with the same PM groups that will do SFR and small multi's, versus the (typically) more professional large MF management groups that will only take on 100+ unit properties.  In the SFR/small multi space, the best I have heard is "my manager is fine".

But assuming you are willing to manage yourself or deal with the PMs, then it simply comes down to what's the additional cost to build, what is the additional cash flow you can expect, and is it worth it to you?

Adventures in CRE has a mixed-use model you can buy for pretty inexpensive, if you simply need a cash flow model to put in inputs. But the harder part will be determining your actual inputs to use.  Market rents, market expenses, loan terms (both construction and long-term loans).  You will run into allocations of NNNs, and what can be billed back to the dental practice and other retail tenants, and what needs to absorbed within MF allocation, etc.  Nothing is terribly difficult, it is just making a lot of calls to understand what the inputs should be, validating them, and plugging them in.

And lastly, like others noted, if I could afford to do this without a partner, without taking on too much financial risk, for me, I would do it myself.  Adding investors adds more complexity in the whole process.  But, at the same point, I imagine just the construction cost of 10 apartments will add $1.5-2mm in additional cost, which in theory means $400k, minimum, of additional down payment.  For many that is not an investment amount available to put into a single project, and if that is you then you may need to seek out partners.  I would focus on other dentists, who typically are fairly high earners, see the value in owning their real estate, and likely already within your network through your wife.

Ryan Schaefer · Answer

Great feedback. Thank you!

After several single-family properties, our goal is to get into multi-family. Maybe I’m being too optimistic, but given only 10-12 units, I had planned to take the same management approach. (I manage administrative, financials, etc. and have a PM who takes the tenant calls and coordinates repairs as necessary.) Perhaps I’m naïve thinking this would scale up?

Our other major unknown is financing. Up to now, my only conversations with banks has centered on purchasing land and the smaller MOB with no apartments above it. In this approach, we were thinking SBA. If we occupied the entire first floor (51% of building) instead of half of the first floor, could we still use SBA to do the ground-up given our mix-use plans for the second floor?

Simmy Ahluwalia · Answer

Yes, to the O/O suggestion.

Ryan Schaefer · Answer

Thank you. Those are good points. On parking, we have already done preliminary site plan and know we have enough parking space for 7000 soft MOB and also a 10,000 sqft retail. But we aren't interest in doing the retail right now. We are interest in the residential.

Snow removal is luckily not a concern. Zoning will require an elevator. Sound is a potential issue, although I would hope that can be mitigated by the building design. (Our office is currently located next to other tenants, and we have never had any issues.)

But are there tools to analyze this from a financial perspective? ROI is the big unknown for me right now.

Bill B. · Answer

A few things you may or may not have already thought of…

Plenty of parking for all the tenants (figure 2 cars each) plus all patients? Neither will be happy if there’s no where to park. Is covered parking/garages expected in your market? I didn’t see it listed in your profile or post so do you need snow removal? (Much easier with empty medical parking lot than full residential lot, especially if there’s no where to move them to.)

Plenty of sound separation? (Patients don’t want to hear tenants and tenants don’t want to hear medical/dental equipment.

Plan to have an elevator or only offer less desirable stair access? (At least for elderly, kids/pets, mobility challenged and moving furniture in and out.)

Nearby place for kids to play and pets to poo? (Preferably without walking through the parking lot.)

Additional utility costs? (More service and many more meters.)

That’s all the easy ones I can think of. Good luck.

Ryan Schaefer · Answer

Great info. Thank you. I agree about the synergy; doctor/dentist is not as good as retail for that. However, in our case I believe it kind of gets two birds with one stone, right? First, we've already pre-leased for half of the first floor (my wife) and second, it is rent replacement for her.

Given the location and community need, I think we could likely pre-lease for the entire commercial and also have immediate interest in the residential. Do you agree?

So on the surface, it seems like a great opportunity. Can you suggest tools I could use to analyze the numbers and my assumptions in more detail?

Multi-family on top of new medical office?

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