Starting out- commercial vs. residential?

Question

Hi Group-

I've been reading and saving diligently to make my first transaction. My investment goal is to secure some  passive income through real estate on a cash flow basis. I have focused my studies on residential income property, and gravitated towards the idea of a multi-unit building near a major university.

I thought I was doing well, until I started reading posts from people who specifically recommend against residential property for people like me. I am an employed (i.e.: employee) healthcare professional with excellent base income, but a very busy schedule. I love my work, and don't have any interest in "quitting my day job" in the near future. Nevertheless, I like the idea of having positive cash flow (who wouldn't?!) and putting my liquid cash assets to work for me.

A lot of people here are recommending commercial real estate for passive income, but I honestly know nothing about it. Is the general consensus that residential real estate is too time consuming, even if professionally managed? Would anyone be willing to give me the "reader's digest" version of how cash flows through a commercial property, and a what the big picture looks like? Finally, are there any particularly good resources that you can point me towards where I can learn more?

Any help, insight, opinion is greatly appreciated!

Thanks,
D

Doug G. · Answer

Yes, good points, and I'll take that advice! I'm mostly targeting graduate students and young faculty. Although grad students are just as cash-strapped as their undergrad colleagues, they also tend to be more responsible and concerned with things like credit. Due diligence seems to be the key in any case.

Uuuf. I didn't think about that. I can see where things could go Bad very quickly if you get the wrong tenant in a commercial property, particularly since many small businesses fail.

There are a few options here for "rental management companies" that will basically collect rent, do some minor building maintenence, and field phone calls for a percentage of the monthly collected rent. I'm in touch with a reliable handyman that can handle basic repairs. I've budgeted for these expenses into my cash flow estimates, based on rent prices obtained from CL. I was ultimately hoping to create a business entity that oversees the operations of property management, repair and maintenance. I wanted to hold the property in a separate entity and upstream from A->B. Unfortunately, I'm still struggling with those cash flow details, and wondering if that plan makes real-world sense. I should mention that I work in a very litigious field, so asset protection is a major concern.

One of the reasons I've bookmarked this site- everyone here is really generous with their time and knowledge. Thanks again!

Bill Gulley · Answer

Doug, Jon makes a good point about looking elsewhere as a passive investor.

Triple net leases are not done for apartments, tenants don't pay maintenance, these expenses are built into the rents for residential. A strip center of industrial property can use the triple net approach.

If your area has a high vacancy in anything, yes, that's a bad sign unless you can identify the why and move the property to a higher and better use. You might pick up a large wharehouse and convert it to luxury apartments, but I doubt this is what you're looking for with your hands off desires.

If you call a large real estate office you should ask for the commercial department, you don't want to get a residential type. I'm not sure about your area but here agents must be qualified to do commercial under the broker. There are designations, like a certified commercial property manager but really, these designations come from paying for classes and they don't IMO, make anyone an expert.

In a large RE company here, in the commercial side, there are a couple of attorneys and one X-CPA. obviously they have had specific and related training beyound that of a Realtor. And, there are many successful commercial agents without any designations at all, so I'd suggest you look for one you can first, work well with and secondly, has a track record.

Jon Klaus · Answer

Commercial is not necessarily hard to own out of your area, especially triple net properties.  You might consider buying in another part of the country with a strong regional/local economy and good population growth.

I wouldn't talk to residential agents about this.  Most know very little.  A commercial broker is a place to start.  They don't need to be in your area.  Joel Owens, a BP member and commercial broker in the Atlanta area has posted a lot of good content here.  Also, don't be in a hurry.

Bill Gulley · Answer

Actually Jon said it in short. You will need professional help in a commercial deal that will be successful or luck that would win a lottery.

Multi family could be a good option for you in a college town as vacancies could be strong, but there are some tricks used, like getting the parents to guarantee the lease and cover any damages.

Commercial properties, retail for example can produce great income but frankly the risks are greater as well compared to residential. Maintenance is always more expensive due to commercial codes, and if you select a marginal tenant and they go down the tubes, unlike residential where the tenant just moves on, yours may be more likely to take bankruptcy in the business and you may not receive rents for months.

I usually don't recommend commercial, like a strip center for first timmers unless they participate in a group of other investors and have professional management.

As to cash flow, money moves through real estate about the same way financially, some with fewer problems than others.

What are you thinking as far as management for your properties?

Should mention too, commercial will usually be more expensive per ft for the net dollar of income generally, financing will be more expensive and while it sounds that you have the hp to pull off a loan, it will always be fairly short term, 15 years or less to meet any balloon obligation.

Lots written here about multi family vs single family landlording.

Doug G. · Answer

Thanks Jon- I was not aware that over 4 units is also considered commercial property. Most of the buildings that I have been evaluating are over 4 units. I read about triple-net last night, and it does sound hands off once a lease is secured. Unfortunately, my region is fairly stagnant for business growth and there are a lot of unoccupied buildings around. This is either a great opportunity or a really bad indicator, and I don't know enough to make an informed investment.

How do I locate a commercial professional that can assist me, and what am I looking for in this professional that will distinguish him/her as being qualified? Is it a bad idea to ask my residential real estate agent for help? Thanks again!

Jon Klaus · Answer

Welcome to,BiggerPockets, Doug.

Commercial has a number of different categories that are different from one another.  Residential Multi-family (over 4 units) is considered commercial, as well.  There are areas of commercial where you can be very hands off.  Triple net properties, for example.  These properties are typically occupied by a single business tenant who is responsible for all maintenance and expenses.  That doesn't mean they are no brainers, though.  Buying the right one at the right price, with the right tenant, with the right lease, will likely take professional help.

Even though you don't have time to be active in your investments does not mean you shouldn't perform comprehensive due diligence.  Your education now will make a huge difference going forward.  Perhaps Bill Gulley will weigh in.  I saw he posted a few minutes ago and he has extensive commercial experience.