Why bother with residential rentals?

[propertymanager]

I like to call residential rentals  "VELVET HAMMERS".   A velvet hammer hits you softly over, and over, and over, it's a slow, cummulative effect.  Over a period of time that differs for each investor, the hits (aka BS) start to take their toll.  When your building up it's a challenge, your hungry, over time you just get sick of the never ending BS.  And I don't care how good you screen people the BS never ends.  If screening was the "save all" we'd never have a bad cop, a bad politician, or a bad nurse.  How does a Doctor get through over a decade of schooling and still be a screw up.  All of these people get scrutinized beyond belief yet we still read about nit wits getting through the check points.

fdjake,

Very good posts and I especially like your "Velvet Hammer" analogy.

However, I have found that being a landlord gets easier over time.  As you said, there is a constant level of BS, but when I first started all the BS seemed like a sledge hammer and four years later, it does seem like a "velvet hammer".  It is still an annoyance, but I have become so numb to the stupidity that a LOT must happen before I get too excited.   

I do like your post about commercial property and think that is a natural progression.  It is something that I certainly will pursue in the future as my residential business becomes more mature.  

Thanks for the great posts!

Mike

[smashmouth]

please help me understand this...

if comercial rentals make so much more money and are less of a headache, why don't more poeple do it?  Is it because of the difficulty of financing? 

thanks,
-Rich

[Rich_in_CT]

please help me understand this...

if comercial rentals make so much more money and are less of a headache, why don't more poeple do it?  Is it because of the difficulty of financing? 

thanks,
-Rich

Financing, lack of understanding of the commerical market, far more residential property than commercial, lower price point in residential.  Most people understand residential, they get it.  They know what a mortgage and other home fees cost since they pay them.  They have either rented before or can at least look in the newspaper to see what rents are now.  It's not foriegn and scary.  Never forget this-  if someone can't understand something they will say no, everytime without fail.  Add to the basics other complexities like commercial leases and people run away.

[Frank Chin]

please help me understand this...

if comercial rentals make so much more money and are less of a headache, why don't more poeple do it?  Is it because of the difficulty of financing? 

thanks,
-Rich

Just to echo what Rich said above, the "commercial market" is more diverse and complex. For one, it consists of many segments:

- Warehouses
- Hotels
- Office buildings
- Medical centers
- Apartment buildings (as some mentioned, same issues as SFH)
- Retail
- Land
- NNN Leasing

You'll need to delve into the economic dyamanics of each, which entails understanding the "supply and demand" side, that affects the success or failure of an investment.

Often, zoning, demographics, and transportation come into play

Because my dad had some success in his "stores", and looking at "good vs mediocre" commercial investments, I used my dad's investment as a basis against what others are measured. So I analyzed small strips, and buildings that contain one to a few stores.

There are many categories of retail, and for small retail, I've looked at:

- Downtown stores and strips, in a suburban setting.
- Neighborhood strips in urban areas.
- Older ubrban strips, i.e. small building on a major road with a few spaces in front
- New strips from 6 to 12 store with lots that can park up to 100 cars.

And when I look at these, I look at vacancies, and what type of businesses that characterize the area, and the type of clientele that patronize the establishments.

Of all of these, downtown stores in suburban settings has the most issues, and risks. Their main cleintele and workers in that area. Restaurants here mainly serve workers at local courthosues, office buildings, and is often uneconomic to open after hours or weekends. Suburban shoppers don't go to dwontown after hours or on weekends.

Neighborhood strps in suburban areas supply  a range of services from restuarants to beauty shops, stationery stores etc. Because restaurants pay the highest rents, usually older neighborhood strips come up short. Who wants to go somehwhere to eat, and can't park.

Store in urban areas are interesting. I live in the edge of NYC, with a lower population density. Where I am, twenty years ago, one out oof three stores are vacant, so they can be snapped up at good prices. But, what are you going to do with a store where there's another vacnt one nearby, with cheaper rent. Vacancies kills rents.

But little by little, in the last twenty years, vacancies filled up, and I figured rents should be going up. But wait. Most of the new businesses opening up are dry cleaners, nail salons, and Chinese takout. And now there's abarber or beauty shop, a dry cleaner on every corner. I also noticed I pay LESS for a haircut now than 20 years ago when my barber did not have all these competitors down the street. And because of this, rents did not go up that much either, though building prices gone up. Why?? Land value. So the cash flow is much poorer.

How does this compare to my dad's area.

First, it's an older area, more dense, with no vacancies. His stores are three blocks from the main shopping district, and since people in the area walk, they pass the local store before they get to the major strip. Because rents "out of the commercial district" are lower, these merchants in theory can charge lower prices.

Your FREIND in these areas is zoning. In many older residential districts, older commercial structures are grandfathered so someone just can't build a store down the street. My dad's store, and his tenant, would not have new competitors because no one can get any place nearby zoned for a store.

In many areas, with less restrictive zoning, say the Houstan area, commercial investors would have a hard time of it, even if he got a paying tenant. His tenant can just have a new competitor open up down the street from you, when someone buys a piece of land, and just throw up a shopping strip.

You see, commecial investing involves more aspects. For SFH, what on earth would the price of a haircut have to do with things. But in commercial investing, it does have a major bearing, as barbers might not be able to pay the rent any more.

Another sign of higher rents on small businesses is all the local Carvel ice cream franchises are opne on Xmas and New Years Day. When I was a youngster, they're close for their winter vacation from Nov to the following March.

Several strips I looked at that contain restaurants I skipped. If I go there on a Saturdaynight, and the place is dead, then I figure the tenant would have a hard time paying the rent. Usually, I can tell even before going Saturday nights just checking out nearby restaurants with better parking, and better access.

Another telling sign of a "low rent commecial area" is the prevalance of storefront churches, AA meeting site, or use as storage for local plumbers. These guys pay the lowest rents. The highest rents goes to areas with restaurants.

So it's the theory of the highest and best use.

And I'm just talking about retail here. I haven't even begun warehouses.

[Rich_in_CT]

Frank-
As always a good, long and concise post. 

Who wants to go somehwhere to eat, and can't park.

This point is paramount folks.  Across the street from where I am sitting right now is a place that has housed a few restraunts in the past few years, the place that is currently occupying the spot is almost never open anymore and is soon to fully close.  I think they only cater now mostly.  The problem?  Parking!!!!  There are about 5 on street spots on their side and 5 on the other side.  The problem is that there are a few businesses on that side and 2 banks on the other side sharing about 10 spots.  If I had to spend anymore than 30 seconds looking for parking I would go to one of the other 8+ restraunts in this tiny little town, most of which have better parking. 

Let me break this down in digestable terms, there are only *3* things that affect real estate:

1) Location
2) Location
3) Location

If all of that fails, location.  I'm dead serious.  In my own town which is 40 miles from here there are at least 3 spaces that REGULARLY open as new restraunts.  These three spots see more turnover than ANY warzone residential you'll ever see.  If you think a residential tenant staying 6 months is bad some of these spots have had 3 tenants in the past YEAR.  The locations suck for them, plain and simple.  They are all on main roads but none the less they aren't in the right spot and they get killed every time.  And when you get into the right locations the land prices are insane. 

I'm going to use my cousin for a few examples here to map out a few things:
About 10 years ago he sold off part of his farm to Walmart and on an outparcel of Walmart a Ruby Tuesdays.  Price, $2.6mil.  Imagine you the new investor wanted to build a strip on that parcel, how could you begin to think about it?  First off purchasing the land, no bank is going to touch much over 50% LTV on raw land.  Got $1.3 mil?  Next you've gotta prep the land, grade it, run utilities, etc.  I don't want to even begin to speculate how much earth they had to move to get that land ready to build.  Then they had to deal with construction costs, even if you aren't building a Walmart your strip would be the same square footage or a tad smaller.  Sound like fun so far?

Ok, another story....same cousin.  The Walmart land was across the street from his farmstand and garden center, he sold it 10 yrs ago.  About 2 years ago he decided to close the farmstand and garden center and build his own strip mall there.  He is going to retain ownership of it.  Now, he already owned the land.  He also had the Walmart money.  He also sold a lot of land behind the farm to condos, etc.  So he's not cash poor by any means.  Despite all that he still needs more cash to do the buildout.  So he goes and get himself some leases for the space including an anchor, I think it was a Chili's.  Now with him owning the land and bringing cash to the table plus having leases ready to go with a national tenant the bank approves him.  When the anchor store pulled out of their lease the bank pulled the loan.  Even despite him owning the land, having I don't know how much cash to throw in he still had financing issues.  I think he is now again resuming the build and hopefully he'll get it built and open soon.  I can't wait to see the finished product.  He's keeping some greenspace in the middle and putting in a park so it's not going to be your typical strip.

This stuff isn't easy kids.  Unless you really know what you're doing stick to residential. 

[coglethorpe]

This stuff isn't easy kids.  Unless you really know what you're doing stick to residential. 

What resources could one look at to begin learning about commercial real estate?

[Rich_in_CT]

This stuff isn't easy kids.  Unless you really know what you're doing stick to residential. 

What resources could one look at to begin learning about commercial real estate?

Start small and move up.  Master small residential, then start growing up. 

[fdjake]

What you guy's are talking about here is the MAJOR LEAGUES of commercial investing.  I'm 42, I have about as much of a chance owning real estate across the street from a Wal Mart as I do starting in Left field this week for the Boston Red Sox.   Don't confuse that type of commercial investment with what I was talking about.  

I do not build $3 million retail strip malls.

I do build $300,000 to $600,000 commercial industrial/warehouse/business space.  Off the main drags, but close to the highway on/off ramps (by close I mean 1-2 miles)

A 3 family home right now in my area sells for $300K  It generates about $2100/ month in gross rents (when they pay) in other words it's a LOSER!

I have cash available through selective buying and selling of single family homes.
I would rather take that cash and build a $400,000 two unit warehouse/industrial rental that rents for $4000/month gross than screw around chasing morons for $700 per floor every month of my life.

You need to know how to BUILD to do this.  If you think your going to find these things sitting around for sale YOUR NOT.  They're cash cows, no one sells them.   You have to build them yourself.  That's the niche folks.  How many of you guy's here could do it???  I'd bet it would be less than 10%.  THAT is my advantage.  It could be your's too.  

Your going to need AT LEAST enough money to buy the land cash.  But if your buying and selling homes that is an achievable goal.  While your buying and selling those homes build a realtionship with a local bank.
Using your home equity to buy and sell houses doesn't show the bank anything.  You need to get a credit line established for your business and SHOW them you know how to make THEM and YOU MONEY!!!!
Once you do that believe me they will have no problem financing your first SMALL commercial build.  Start small, check and recheck everything, then when it's successful, repeat at a slightly larger scale next time.

Don't write this stuff off, it's the best real estate investment you'll ever make.   Just wait until Propertymanager gets his toes wet in this stuff. We'll all be reading about him selling ALL his houses to build more commercial.  It eventually happens to all successful real estate investors.  Just watch.

[Rich_in_CT]

I'm just trying to say that anything like this is going to be much harder than residential initially as there are a ton of other variables.  And like you say you need to really either buy the land cash or at least put a hefty down payment towards it.  This puts these out of the realm of a starting investor most of the time.  A good move to make for someone that's already built up cash and some experience in residential.

[fdjake]

I agree with you Rich,  it's not for new guy's but it SHOULD be something everyone strives for.  I still to this day can't believe how much different commercial is compared to residential.  At least 80% less BS.

Your right on your points though Rich, it takes more money and more knowledge, but it is definitely worth getting there.

[Rich_in_CT]

Personally I'm shooting for something like this:  http://www.newbostonfund.com/properties/prop.asp?id=30

[fdjake]

Yea, start small

[Frank Chin]

I do not build $3 million retail strip malls.

I'm not talking about $3MM strip malls either.

I'm talking about buildings in downtown that goes for $300K, or a neighbohood strip that goes for $600K, with buildings on it, today.

Way back, when I bought a 3-family for 180K, a storefront with 2 apts converted to offices upstairs commanded slightlly hiigher rent even, with 90% less work, selling for 200K. Financing was a bit trickier, as it required commercial loans, and banks don't like doing commercial loans that small.

We passed on it because based on what my dad said, a vacancy can take several months to fill, and you got to be picky, unlike residential around here. We opted for the safer investment. But we felt we didn't have a six to 9 month cash cushion.

Eventually, a retail travel agency occupied the store, and it's been there for over 20 years now.

Another opportunity I missed was a building that housed an Irish bar, an anachronism now, with several garages out back, and an apartment on top. It was in the border of a residential and industrial area. The old building really looked ugly, and it was going for less than 200K.I looked at it as a blight in a residential area.

Someone snapped it up, resided the place, cleaned it up, put in a laundromat, and converted the garages to several small stores, housing a nail salon in one, a small beauty salon in another.. The upstairs were converted to offices. The corner is busy nowadays, the laundromat is always jam packed. It was exactly what I was looking for as the nearest strip is several blocks away, as the location is grandfathered. No one is going to open a laundromat down the street. Unfortuantely, I spent too much time thinking about it.

This is the type of commercial investing I'm talking about. And rehabbing something like this is far cheaper than building new, and far faster taking into consideration governmental approvals .







 

[fdjake]

Excellent point Frank.  I know a guy who does just what your talking about.  He's a remodeling contractor.  I've seen this guy take old crappy looking buildings, rip the vinyl siding off, reframe the front facade, then cover everything with Dry-Vit and BOOM!! Looks like a completely different structure.

He always seems to have them fully rented within a few months of the completed rehab.

That leads to another interesting observation.  I have noticed that a high exposure ugly building that under goes renovation is like a giant BILLBOARD.  People and potential renters pass it everyday and watch it's restoration. That building is getting attention!!  Everybody see's it. Ever notice how most of those buildings are always full?

[coglethorpe]

I do not build $3 million retail strip malls.

I do build $300,000 to $600,000 commercial industrial/warehouse/business space.  Off the main drags, but close to the highway on/off ramps (by close I mean 1-2 miles)

That's an important clarification.  Now that you mention it, I always wondered who put up places like those.