Small Mixed-Use Commercial Opinions

[Mike Trzaska]

I've been actively looking for my first rental property in the Cleveland area for the past few months, primarily I was focusing my search on duplexes, tris, and quads. I've recently been looking into small mixed-use commercial, typically buildings with 2-6 residential units and a couple storefronts.

In the same area where I have been looking for residential properties (and have been outbid on 5 offers) I am seeing small mixed-use buildings with 3-4 residential units and a store front for similar prices as triplexes in the same area. 

Looking at the income and expense numbers the mixed used properties would cash flow nicely. However, the cap rates I have seen in sales data for comparable properties are around 12%, where multi-family cap rates in the same area are around 8%. To me this small mixed used buildings look very attractive, but I am apprehensive about getting enough appreciation to cash myself and a potential investor out with a refinance in 1-3 years.

I'm looking for some guidance from those that have experience in these type of properties on the below:

-What are the drawbacks of these types of investments?

-Why such a big discrepancies in cap rate between these buildings and residential in the same area?

-Are these properties typically just a cash flow play or is there appreciation to be had in a good market?

-BONUS: Some of the properties have a bar on the ground floor, what should I consider before being a landlord to a bar?

Thanks in advance.

[John Lenhart]

A few considerations. 
1) a 6 unit apartment and a 2 unit C class commercial and 4 unit apartment on top will probably have pretty similar revenue (I am assuming it is a lower class commercial property given the building age and size you describe, and I know Cleveland has a ton of older properties like this)

2) while there will be some advantages to having a commercial tenant, if they are a smaller business like a local bar, chances are the owner does not have much additional capital outside of their small business (I hope it is run well for their sake). These properties do not cater to national tenants like a Starbucks or Panera. 
3) when an apartment comes vacant, you can get it rented in 2-3 weeks, but if a commercial space would come open, it could take 6 months or a year to find the right tenant for the space and involve capital concessions on your end to get a tenant in.
4) for the reasons cited above, the commercial income would need to be a decent amount higher to overcome the increased vacant risk and re rental risk than just a life apartment building. 
5) Retail is just riskier in general for the reasons stated above plus you then add in that your retail tenant is probably not the strongest credit risk.

6) mixed use is harder to finance. Some lenders specialize in apartments, some retail, some industrial, etc. while you can certainly find lenders who will lend on the property, the available cash in the marketplace to lend on a mixed use property is not as readily available as it would be for other straight forward asset classes

This would help explain why the cap rates would be so different