Why invest in commercial real estate?

Question

Hi,
I am a new investor trying to figure out if I should focus on investing in apartment properties or commercial real estate (retail prop., strip centers,etc).
Suppose you can make a true 14% cap rate (includes 50% maintence + property mgmt expense) on a apartment; why or is there a reason to invest in commercial real estate when most commercial cap rate is less than 10%? Not only that, aren't interest rates for commercial real estate higher than interest rates for apartments?
I often hear that one advantage of investing in commercial re vs. apartments is less management; but doesn't that advantage seem moot if you can hire property management and still have a higher cap rate?
Another thing I hear is that commercial re appreciates faster than apartments? Is that true?
Also, with apartments the leases are generally shorter term so you can take advantage of market pricing..but I guess that can go both ways.
Having said all that, a part of me still wants to invest in commercial real estate...don't know why? :) Hoping someone can convince me one way or the other.

Appreciate your thoughts. Thanks.

Don Konipol · Answer

I have found investing in apartments to be much more difficult than in many areas of commercial real estate. Price competition seems to be much stronger, non payment and eviction much more likely, good property management much more difficult to find, operating costs much higher, tenant problems much greater with much more frequency and net operating income much more volitile. Commercial real estate covers a huge area, many investments differ so greatly from each other I hesitate to categorize them the same. I have had a lot of success with single tenant property - have had many properties that had same tenant for 10 years or more, CPI rent increases, tenant taking care of all repairs and even improvements, rent check always on time, and no tenant complaints or requests. If I can get a 10 cap on a good condition property in a growth area with CPI rent increases I'd grab it - long term great ROI with few problems. Apartments CAN be put on auto pilot with management, but to do so requires a large apartment complex - 250 plus units - and in the A or B category. Most investors are looking at much smaller complexes in the C or D category. These do not attract the best property managers, require much more of an investment in time and supervision from the investor, have much higher operating expenses as a percentage of income, carry higher financing costs, and are subject to much more income volitility. I suspect that the apartment complexes for sale with a 14 cap are the ones with deferred maintenance issues, in low income areas, with little appreciation potential, high turnover, high eviction, and plenty of intense management "opportunities".

Bill Gulley · Answer

....newbie, the comments above I agree with and commercial can be less "trouble" with respect to tenants and maintenance. However, usually when something goes wrong, you will see that the risk reflects the return as with anyother investment. Remember too, that in real estate investments managers are not held to the standard of say, stock brokers or your CPA. There are good managers and bad ones, and like a stock broker, what clients receive closer attention, the client that has 12 units in a strip center or one who has 120 units under management? Commercial is a world away from residential investing and being new, I would suggest you go beyond the due diligence of real estate and look into the economic conditions as well as understanding the types of buisness tenants you might be working with. You'll also be responsible for many more compliance issues in commercial, EPA and material disposal issues, local fire codes, the list is endless. If you have a strong business background, moving directly into commercial investing could be for you, it is not for most beginning investors. Just because you have a manager, doesn't mean you'll have success, you will be responsible for your that. Good luck...

Bryan Hancock · Answer

Great post Don! Thanks for sharing! That has been my experience as well. High cap rates generally go hand-in-hand with high hassle and high maintenance. Nothing is free!

Rich Weese · Answer

I agree 95% with Don post. The only caveat is the size and mgmt of the property. I've also owned many sfrs and apt buildings. I currently have a cat C 154 unit building. I have a great pro mgmt company and also a great on site mgr and asst. In this economy, good employees are everywhere. It is on autopilot. In year of ownership, I've visited property 2 times. It has averaged 95% occupancy for the year. If you have enuff sfrs in same area, they can also been put on autopilot. I have 30-40 sfrs in same area of TX that are also on autopilot. Rich

Sue T. · Answer

Don, Thank you for your thoughtful response; it is really helpful to get perspective from someone who has experience investing in both.