why dont more people invest in commercial real estate?
Real Estate Investor · boston, NH · Member since 2014 · 401 posts · 32 votes
why dont more people invest in commercial real estate?
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Real Estate Investor · Remond, WA · Member since 2015 · 23 posts · 15 votes
11yI started out in commercial real estate and I think honestly most people are just scared of it. I honestly don't agree with what a people are saying about it being so much more risky or needing to understand the business's that much more. There are certainly different factors involved in Commercial, but I don't think it is any more complicated than a Multi-Family deal.
Going out and buying a large single tenant building certainly has some big risk factors, but starting out in commercial strip or flex use warehouse can be an excellent avenue to generate both wealth and knowledge. The key is to understand a cash flow model and understand vacancies in the market as well as leverage. Down payments can be a bit higher of course so some people will shy away from it.
When I started I had a few rules:
1. Must cash flow today.
2. Won't go over 70% LTV.
3. Must have upside.
4. Must be in an appreciating market, though I do not factor appreciation into my cash flow model.
5.) Must have 3+ tenants.
By putting some basic safety nets in and not going outside of these, you can find some great commercial properties with the protection of a multi-tenant operation. Some of your tenants will fail and you will have to factor in rolling new leases into your underwriting. Understand how much professional property management cost, understand how much professional leasing cost and get an idea of what Tenant Improvements might be for a new lease in a building you are buying. Some of my C class buildings I put almost no TI money into them and some of my A class buildings might be $20+ a sq. ft. You need to know the market you are buying into, but that is just a variable in your underwriting.
Figure out the fundamentals of real estate from an income/expense perspective. Play with best & worst case scenarios a bit and buy something that seems solid that you believe will perform. I intentionally avoided M.F and S.F.R as I wanted to go down the path less traveled. I took my time, was patient and have found plenty of great deals in the commercial space. As I gained knowledge and credibility I was able to buy large properties including some large single tenant building's that are very strong. Don't start there though. Keep your risk in check and you can enter that market.
IMO, the Seattle market is out of control when it comes to both SFR & MF. I would not buy either right now. I think the risk in buying MF that is at a severely compressed CAP is higher than buying a quality strip center.
Tim
39 Replies
- Investor · Colorado Springs, CO · Member since 2013 · 643 posts · 280 votes11y
@Account Closed I'm not an expert, but here's my insight...
1) I think it is generally easier to buy and sell residential real-estate, especially single-family homes (sfh). If you're looking to sell a decent sfh, you should have both investors and owner-occupants as possible buyers. When you a selling a small multi-family (2-4) or a commercial property, you have have a much smaller pool of potential buyers. This could impact time on the market and your ultimate sales price.
2) Cash and financing is also a major issue. Commercial properties generally cost more, hence you need more cash down and the financing can be a bit more complicated.
3) Education. It is pretty easy for people to understand the numbers and concept on a single-family home. Commercial properties, from apartment blocks to office buildings and warehouses, are a bit more difficult for the novice investor to get their mind around.
For me personally, I'm learning with single-family homes and small multi-family homes. In time I would like to do some larger deals in the commercial real estate space.
Mike
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes11y
Night & Day
Don't neglect the smaller $$$ mixed use commercials.
Several we own were around $50-$65K CASH & the returns are >21% p.a. We recently lost out on another, (it sold for $83k), & generated over 30% ROI.
Another owned by my youngest daughter generates 22%.
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes11y
Took ten minutes to think about what to say due to the vast difference. The question is so vague it would take several books to explain commercial concerns. Even small mixed use requires business knowledge beyond that of residential, you need to basically understand the business your tenant is in, environmental concerns, hazards, basically what your tenant does and what risks they may pose will determine if they will be successful or if you'll be empty. If you understand such matters you might consider a small mixed use, a store front with 4 or 6 apartments, but the commercial side can kill your investment if you don't understand the management.
There are CCIM courses for Realtors, look at the course outlines and you'll see how different commercial can be. As Joel said, it's day and night! :)
- Scottsdale, AZ · Member since 2014 · 659 posts · 536 votes11y
I own both a retail strip center and apartment buildings. The apartments are fast moving and labor intensive. The retail side moves very slowly. Vacancies take time to fill correctly. It can take 6 months or more to get a new tenant moved in once a lease is signed. The level of the people that you are dealing with for the leases and how they are negotiated are completely different.
I feel that commercial can have some "value add" components to it but again this is much slower to materialize. Apartments can have much quicker pops.
- Real Estate Agent · Southbury, CT · Member since 2013 · 160 posts · 98 votes11y
Commercial buildings are more of a rich person's game. What is nice is that a tenant is usually locked in for years do the turnover is less but from what I have seen the ROI is significantly less. So you put out more money in Order to make a lower percentage. If your looking to grow fast rental properties should out produce commercial properties. On a personal level I also like that not all your eggs are in one basket.You can get a few rental properties for the same price and somewhat diversify their location.On top of that losing a tenant hurts less in rental properties.
- 11yRoy N.Pro MemberRental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
Originally posted by @Jason Arcuri:
Commercial buildings are more of a rich person's game. What is nice is that a tenant is usually locked in for years do the turnover is less but from what I have seen the ROI is significantly less. So you put out more money in Order to make a lower percentage. If your looking to grow fast rental properties should out produce commercial properties. On a personal level I also like that not all your eggs are in one basket.You can get a few rental properties for the same price and somewhat diversify their location.On top of that losing a tenant hurts less in rental properties.
Jason,
Apologies if this seems a little harsh, but your perceptions are mostly incorrect.
Yes, commercial properties do frequently require more capital than residential to acquire. This is predominately factor of their scale (a four unit strip mall or 50 unit apartment building generates more revenue than a duplex and will cost more).
In terms of returns, commercial can produce greater ROI than residential; particularly when you move away from apartments (multi-family) and into retail, office or industrial. While residential leases (in either residential or commercial sized properties) are typically heavily regulated, commercial leases in retail, office and industrial come with fewer handcuffs. In a commercial lease, the tenant can be responsible for far more of the operating expenses (even the property tax) and maintenance, which lowers the landlords costs significantly.
As you mentioned, commercial leases tend to be longer than residential - 5,10, even 20 years are not unheard. Lease-up times also tend to be longer and the owner/landlord needs to be able to carry the property longer between tenants. Location is also more critical - a strip mall near a busy intersection or office space with solid transit links increase their appeal.
In short, commercial properties can be every bit, and more, profitable than residential rentals; can be more hands-off and offer greater stability with longer leases.
- Real Estate Agent · Southbury, CT · Member since 2013 · 160 posts · 98 votes11y
When I was looking at commercial properties in my area, I was getting around 8% ROI. The rental properties I go for I look for come in between 15% and 25% Obviously every market is different and it also depends on location and quality. Like my buddy in DC can't find a rental property that really makes anything unless he puts a crazy percentage down. I get what your saying about the lease terms and I'm sure someone who has experience with leveraging this ability can get greater return.
- Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes11y
@Account Closed
I've seen many even national commercial tenants with NNN cap rates for 4, 5, or 6%. Many residential owners would not accept cap rates that low. Here there was a 2 adjoining parcel sale both with long term leases, one to a national and one to a large regional, sold for $5 million with a cap of 5, sold in less than 30 days for cash. Now the buyer of that has very little to do, since NNN and will get $250,000 a year rent for their $5,000,000 cash purchase price. After income taxes their net probably will be significantly lower, as they will be in the 43.4% tax bracket, though the will have significant depreciation, for the next 39 years.
One big difference between residential and commercial is the financing. For residential we've gotten as much as 100% financing (but never did get any of the 125% money). whereas for commercial we would typically get 80% financing at best. We've had retail stores, attorney offices, commercial kitchen, car dealerships, repair garages, farms, timber land, developments, and even an abattoir.
Residential is easier to finance, easier to understand and easier to buy, plus there is a tremendous supply.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes11y
Commercial is more tied to tenant quality and the lease backer.
Equity growth in commercial can be phenomenal.
People make and lose money everyday with ANY asset class. So I will not buy the argument that it is more risky.
The dynamics of the investment are just different. People do what they are comfortable with.
You can have more risk in my opinion with the small mom and pop type oddball properties that are considered commercial. Yes those generate higher returns potentially for a small price but tend to be harder to re-rent.
If you own a quality strip center for example in a prime area re-renting tends to go quick as many corporate tenants will go in that space that wouldn't give the oddball property the time of day. Cap rates can be lower but you can also land loan rates below market not found on oddball type smaller properties.
If you have 4 properties in average to crappy locations over 1 property that is in an excellent location is that better?? To me it's not.
So you can have diversification but sometimes that can be a bad thing as well.
Positives and negatives to everything in life......... : )
- Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes11y
There are other different factors that affect commercial. Right now there is a lot of on line sales which affects retail brick and mortar sales. Just look at Radio Shack, Sears, Penney, and other retailers that are suffering. right now on line sales and factory outlets are doing the best business at the expense of other retailers. Main street retailers are suffering and there are commercial vacancies both at Main St. ; strip centers and malls. Often times these commercial vacancies are long lasting, sometimes years. Other commercial sites are specialized and are not suitable for many other uses. There is an off brand quick lube type place here that went out of business and the building has been empty for years.
But sometimes a building is empty but still generating income. A large grocery chain here had a long term lease on one of their stores. Another superior location close by became available and they jumped on that site and build out a new store and moved there closing their old store, known as "going dark". There lease said that they had veto rights over new tenant for their old site and to take over their unexpired lease term. The lease specifically said that they could reject any new tenant that sold food, since that would be in competition to them. so no new grocery chain could move in.
They also rejected Barnes & Noble as a new tenant, since B&N had a café and served food. The place was "dark" for years, the exited grocery chain was still paying the rent and keeping competition out. Finally the place was rented to Williams & Sonoma for a call center.
- Investor · Cincinnati, OH · Member since 2013 · 2k+ posts · 1k+ votes11y
@Account Closed talk about casting a wide net - that question could be answered in volumes of books! :)
While you need education, strong relationships and money in residential and commercial - there are different aspects of each of those three that are required when looking at residential vs. commercial.
Education - with commercial, it's a different type of education because you're introduced to new terminology, deal structures, financing, due diligence and underwriting.
Strong relationships - because commercial is such a small world relationships are critical to your success. This surprised me the most when I got started in commercial after being a residential investor.
Money - you need money to invest in commercial real estate. Yes, you can do a large deal with little to no money (I have personally done that) but you still need cash reserves in case something bad happens - and it will. Otherwise, you'll lose the property or sell for loss and that ain't the way to play the game.
Net-net, I think there are less people in commercial because the barrier is higher but, of course, the returns can be greater too.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes11y
My clients and I stay away from big box retailers. I have been telling investors for years to stay away. This make sense for big REIT's or funds who can own 50 of them and still come out ahead if one is dark for 12 months.
Radio Shack and all of those types I have know from years they have been hurting.
For retail you have catalogue sales, online sales, and brick and mortar. They can work in synergy with each other to grow the business instead of negatively affect it.
The centers I look at are DESTINATION type tenants. Hair cut, karate school, gym, restaurant, doctors office, dry cleaners ( the new green kind ) so no EPA issues down the line.
These are places where the customers have to go there and spend money to do business.
I am not interested in clothing stores, hobby shops, gaming centers, etc. where the tenant could be a zero or a hero.
NOW if the clothing store tenant has very high net worth and liquidity with a personal guarantee then the store can lose money and they still pay the rent. In those situations I don't care as long as they pay the rent. Even then for tenant mix I would only want say 1 to 2 tenants out of 10 with that product mix.
So to mitigate risk you build in ( when you buy ) certain assumptions for leasing commission, tenant improvements, vacancy, etc.
If you plan for exits and account for a lot of items people miss and buy right then when these events occur they are not things that take you under.
The nuances are key to successful investing. Those nuances are learned by focusing on an asset class day in and day out.
- Visalia-Fresno, CA · Member since 2009 · 1k+ posts · 863 votes11y
I have a couple commercial properties... the biggest difference that I have encountered is the mindset of the tenants... business owner vs. home renter. Different game and different ways to negotiate.....
Frank
- Investor · Birmingham, AL · Member since 2014 · 37 posts · 30 votes11y
A bad commercial deal can bankrupt you, a bad residential deal and you're still on your feet
- Rental Property Investor · Cleveland, OH · Member since 2013 · 85 posts · 146 votes11y
These are two completely different animals with much different players. The one thing that hasn't been mentioned so far in this thread is forced appreciation. The scale of which you can force the appreciation on a commercial property is so much greater.
We must all remember that commercial property derives it's value from it's NOI and cap rate. This allows someone like Omni Property Companies to purchase a distressed office building, re-tenant it, add value (rents), increase the NOI and sell it for significantly more than what we bought it for.
VERY simplified example:
1 Single Family Home
Rent: $1000/mo
Gross Rental Income: $12000
Annual Expenses: $7200
NOI: $4800
1 distressed office building purchased for $1,000,000
NOI at the time of purchase - $100,000
CAP Rate - 10%
New leases that add $20,000 to the NOI
New NOI - $120,000
New Value of building: $120,000 / .10 = $1,200,000
Voila you just increased the value of this building by $200,000 by simply adding $20,000 to the NOI via lowering operating expenses, signing a new lease, raising rents, etc.
- Real Estate Investor · Memphis, TN · Member since 2014 · 156 posts · 101 votes11y
We have both commercial and residential properties. Besides all of the differences already stated, there is also a huge difference in the tax assessment. For residential here in Memphis, the residential assessment is based on 25% of the value. For commercial, it is based on 40% of the value. People who are looking into getting into commercial are often shocked at the additional property taxes we pay on commercial. Now true, if you have a triple net lease, your the tenant pays the taxes, but if you are without a tenant -- ouch!! We have office buildings with multiple tenants that are not triple net; however, we have it in our current leases that if taxes go up, the tenant rent goes up proportionally.
Another thing about commercial versus residential is that homes are a lot more liquid than commercial property. It takes a lot longer to sell a $1,000,000 building than it does a $300,000 house.
I personally love having the variety in our portfolio but commercial is not for the faint of heart. On the personal side, I would rather deal with a corporate client any day compared to a residential one. I manage our commercial properties. I would never manage a buy/hold residential. That is why we have concentrated on flips on the residential side, so we can have more cash to buy more commercial properties in the future. ..... Just my humble opinion!
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes11y
Everyone has a view on things.
"A bad commercial deal can bankrupt you, a bad residential deal and you're still on your feet"
This is my opinion isn't a true statement. This is more about the individuals liquidity and net worth levels than whether it is commercial or residential. If the down payment is small compared to the overall liquidity then the odds of floating the property longer have increased whether residential or commercial.
Larger commercial loans also tend to be non-recourse in nature. So If a property was draining you heavily then simply throw the keys back to the lender. Especially if you have other properties performing well and those have gained big equity then cut your losses on the loser of a property.
"Another thing about commercial versus residential is that homes are a lot more liquid than commercial property. It takes a lot longer to sell a $1,000,000 building than it does a $300,000 house."
This also in my opinion is not true. What I find is that owners who are heavy into residential but dabble in commercial do not have the deep networks of commercial buyers. So the perception is because they simply know more residential investors and people that commercial is harder to sell.
Someone that does commercial real estate everyday in the business has tons of well qualified buyers looking for property just like in residential.
So if you know someone very well connected in the business product can be moved fast. Just like any asset class if the buyer overpaid in the beginning then it becomes much harder to sell. I will say that buyers with the kind of money in commercial tend to be more well informed so you do not get a residential newbie grossly overpaying for something. In that perspective in residential you do have more idiots to bail out sellers mistakes of over paying or over improving a property.
80% of the stuff for sale no matter the asset class I would never buy. I am interested in generating wealth and not buying marginal deals that have a high chance of losing money.
- Real Estate Investor · San Antonio, TX · Member since 2014 · 785 posts · 190 votes11y
My partner has invested in commercial. He got out of it. The reason is when the market dives, as it always does, you can get left holding an asset that cost you millions and is now vacant. that is not conducive to sleeping well at night.
He found the better option in our city was to invest in residential, houses under $100 k. Much safer and very profitable.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes11y
It depends again on what type of commercial it is.
I like strip centers. If you have 10 units with 25% down you need to be at about 4 vacant to hit breakeven occupancy paying the mortgage.
If all your tenants are mom and pop those feel the downturn in an economy more than corp. tenants.
Corp. tenants build coffers during economic upswings so that when they offer coupons and specials more in the downturn they maintain market share and still pay the rent.
When the markets dove a lot of people ( investors included) lost their shirt on upside down houses. Residential is not immune to economic downturns and you can easily lose money in any asset class.
If a case study was performed on the commercial property your partner got rid of there might be things found that could have been accounted for on the front end that made it a non-buy to begin with.
I see lot's of stuff people buy everyday where I just shake my head is disbelief.
also remember that WHERE specifically you invest will heavily effect the residential vs commercial equation. In San francisco I know how to create a lot of forced appreciation in small residential projects. You can also do the same with smaller commercial projects here- some brought a few years back when rents were $2-3 PSF in hip neighborhoods and now getting $$5-7 psf. But these commercial props are usually the smaller mixed use types, so they also include a residential component, hence they have residential characteristics.
But the biggest negative for me is the limited financing. 1- as I buy and hold long term, locking in low 30 year fixed rates is a cornerstone of my investment strategy. That benefit goes out the window where 5-10 years fixed is the norm with commercial. 2- for mixed use, especially if under 5 units, when lending gets tough you basically have a (bank) unfinanceable white elephant. You need to set up your bank financing when it's available, otherwise it's private money, which generally sucks for buy/hold compared to bank rates.
Having said all that I haven't ruled out commercial investments in SF. Maybe in my next asset acquisition phase I'll go that direction. How interest rates behave over the next several years will certainly impact my thoughts on this!
- Real Estate Investor · Remond, WA · Member since 2015 · 23 posts · 15 votes11y
I started out in commercial real estate and I think honestly most people are just scared of it. I honestly don't agree with what a people are saying about it being so much more risky or needing to understand the business's that much more. There are certainly different factors involved in Commercial, but I don't think it is any more complicated than a Multi-Family deal.
Going out and buying a large single tenant building certainly has some big risk factors, but starting out in commercial strip or flex use warehouse can be an excellent avenue to generate both wealth and knowledge. The key is to understand a cash flow model and understand vacancies in the market as well as leverage. Down payments can be a bit higher of course so some people will shy away from it.
When I started I had a few rules:
1. Must cash flow today.
2. Won't go over 70% LTV.
3. Must have upside.
4. Must be in an appreciating market, though I do not factor appreciation into my cash flow model.
5.) Must have 3+ tenants.
By putting some basic safety nets in and not going outside of these, you can find some great commercial properties with the protection of a multi-tenant operation. Some of your tenants will fail and you will have to factor in rolling new leases into your underwriting. Understand how much professional property management cost, understand how much professional leasing cost and get an idea of what Tenant Improvements might be for a new lease in a building you are buying. Some of my C class buildings I put almost no TI money into them and some of my A class buildings might be $20+ a sq. ft. You need to know the market you are buying into, but that is just a variable in your underwriting.
Figure out the fundamentals of real estate from an income/expense perspective. Play with best & worst case scenarios a bit and buy something that seems solid that you believe will perform. I intentionally avoided M.F and S.F.R as I wanted to go down the path less traveled. I took my time, was patient and have found plenty of great deals in the commercial space. As I gained knowledge and credibility I was able to buy large properties including some large single tenant building's that are very strong. Don't start there though. Keep your risk in check and you can enter that market.
IMO, the Seattle market is out of control when it comes to both SFR & MF. I would not buy either right now. I think the risk in buying MF that is at a severely compressed CAP is higher than buying a quality strip center.
Tim
- Real Estate Investor · Saskatoon, Saskatchewan · Member since 2010 · 357 posts · 27 votes11y
While most of the reasons above are true, I personally think MINDSET is a BIG factor that makes most investors stay away from investing in commercial real estate. Most investors think "its a game for the rich".... its interesting to know that it is actually in commercial real estate that seller finance, master lease options and other creative little to no money financing are easier to get --- if you work within the sweet spot of the commercial real estate.
- Investor · Houston, TX · Member since 2013 · 195 posts · 102 votes11y
Wow some people really don't understand commercial. To those that say commercial properties have lower returns and can bankrupt you, these people are clueless.
Commercial properties are good and bad, just like residential. I own investment homes and some commercial assets that are much larger. I have a bigger headache when it comes to these homes in regards to maintenance. I also own a strip mall with both mom and pop tenants and corp tenants. Most of these leases are NNN. Also I got non-recourse debt on most of my properties, so NO I actually don't go bankrupt. If anything, I get hit harder for an investment house.
Yes, returns may be better for residential, but they should be given all the issues that can arise. Also in many situations the returns are not that significantly different. For example, in Houston, if you want a DECENT house in a nice area, the cap rate is like 8%-9%. There are some nice shopping centers sold in Houston with caps in the 7% range. So yes there is a difference, but in one you get less headaches and non-recourse debt in the other you are responsible for all issues.
For the person that says when the market nosedives, commercial gets hit hard. Ok this is true, but doesn't the same apply to residential? The residential market got hit insanely hard. This is not a matter of commercial vs. residential, this is simply about overpaying.
Honestly, for my shopping center, I had ZERO tenants leave during the worst years of the recession. I did renegotiate one tenant's rent in this period and got them to sign a 10-year lease with a personal guaranty. Good luck getting this for a SFH renter. How you manage the asset makes a big difference.
Simply comparing a NNN Starbucks selling for a 5% cap on loopnet to a SFH in Memphis doesn't meet commercial real estate is awful. I'll admit CRE prices have risen quite a bit, but I know the same has happened for residential. I think both types of assets have their pro's and con's, but to say CRE is a worse investment than SFH is way off. I recommend you do some research. If anyone is interested, there are some very good books out there.
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