Author Topic: Commercial RE, anyone dabble in it?  (Read 1212 times)

rothwem

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Commercial RE, anyone dabble in it?
« on: January 30, 2024, 09:16:19 AM »
My wife started a side hustle recently that is killing it--its already making more than her day job after a month.  We're going to continue on our current course for 6-8 months or so before we make any moves, but in order for her to go full time on the side hustle, she'll need some office space.  I started looking around at commercial RE, and renting an office seems like a really bad value, its thousands of dollars a month for a simple office suite and its not like the landlord really does anything to fix the building--paint, carpets, light fixtures, etc are all on the renter. 

I was considering just buying a commercial building, renting out an office to her business, and finding tenants for the other units. 

The problem I have is that I have zero experience on the commercial side of real estate.  I've got a duplex that I've rented out for 10 years, but residential is a different world from the commercial.

Anyone own a commercial building?  How's it going for you?  How did you get started, and what kind of financing did you use?

reeshau

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Re: Commercial RE, anyone dabble in it?
« Reply #1 on: January 30, 2024, 11:04:39 AM »
Just to say, commercial real estate has a lot of negative sentiment hanging over it right now, as commercial mortgages, typically lasting 3-5 years, hit the need for renewal at higher interest rates.  This has been a fear as the "next big thing" since the regional bank crisis a year ago.  Like the 2023 recession, however, it has not really shown up.  Office leases, in particular, have definitely softened.  And some properties have made waves with defaults or lowball sales.  Banks and landlords can kick the can down the road by extending leases, but banks aren't in a financial position to just suck it up.  To me, it looks like a race between these expiring mortgages and Fed rate cuts, to see which happens faster.

Of course, you aren't looking at city center skyscrapers, I presume.  Suburban offices have done relatively well, and retail even better--those things within the scope of an individual investor.  I don't mean to scare you off; such a crash might bring a lot of bargains. But it will also be challenging for a beginner to navigate.

sayonara

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Re: Commercial RE, anyone dabble in it?
« Reply #2 on: January 31, 2024, 09:58:49 AM »
Hi Rothwem - I worked in CRE and own development land, multifamily and office. My advisement would be similar to reeshau's - Even in the best of times, CRE generally has its own complexities and difficulties, and I'd say those are about 5x more than 'normal' right now due to what's going on with interest rates, debt markets, insurance rates, etc. There is a world of pain going on with, in some cases, equity being wiped out of deals entirely.

It's true that CRE gets the headlines during the good times for its nice tax breaks and big booms, but it is also a very cyclical industry and, unlike just being invested in the market, when the cycle is down and there is a loan maturity OR interest rates / vacancy rise, you can be put very quickly into a position of needing to put additional cash in to the asset (either to fund a cash-in refinance if the value has dropped at the time of your balloon payment, or to just fund the OpEx and debt service and keep everything afloat until vacancy and/or interest rates are reduced).

It will also complicate tax returns with a potential LLC holdco, a whole other layer of accounting for the building, depreciation, etc. etc. Not a huge deal if it's worth it to you, but it certainly does add a layer of additional 'work' to life where you may not want it.

On the other hand, if you have the funds and aren't opposed to a bit of on-the-job learning and growing (and mistakes - I and everyone I know in the industry have certainly made plenty), it could be a good time to buy with values compressed and with some sellers who no longer have the cash to fund their debt service in distress. I would recommend leverage no greater than 50% LTV so you put more cash in up front but have more of a buffer to weather the storms (lenders for CRE can be local banks, national banks, LifeCos, private debt funds... I would find a local mortgage broker and talk to them about pricing the deal for you. A lot of CRE mortgages are 3-5 years with a balloon payment at the end, where you'll need to refinance at whatever the current rate is at that time). Also take a look at rental rates, vacancy in the asset class and submarket that you're looking in - if the place is partially vacant when you buy, how long is it going to take you to lease it up? If a tenant leaves, how long will it take to replace them? Will replacing them require a large capital investment to fix/improve the condition of the space? Many office tenants expect a "TI" Allowance (i.e. tenant improvement allowance where LL improves the space for their needs) from their landlord, as well as potential free rent for a specified period of time at the beginning of the lease. What will the rental rates be, and, are they gross (you pay utilities) or NNN (tenant pays utilities)? Any major repairs, expenses looming? Etc. etc.

Archipelago

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Re: Commercial RE, anyone dabble in it?
« Reply #3 on: January 31, 2024, 11:17:01 AM »
I don't own CRE but I have looked at deals and have people in my circle who are CRE people. In pretty much any successful deal that I've heard about or gotten eyes on, it's most important that an underperforming asset is purchased, then value is added to the property. This could mean changing the building use entirely, building out space for tenants, unearthing use cases for higher paying tenants, raising rents to market levels, reducing operating expenses, or any combination of the above.

This is especially important because the bank values commercial property much differently than residential.

I also recommend starting to build relationships today with local commercial lenders. Get a referral for a commercial lender if you can. Then pick up the phone and call even if you're a year away from a deal. Call them once in a while and build the relationship. That way if the right deal comes up, you're ready to move on it and have your ducks in a row.

rothwem

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Re: Commercial RE, anyone dabble in it?
« Reply #4 on: January 31, 2024, 02:07:00 PM »
Hi Rothwem - I worked in CRE and own development land, multifamily and office. My advisement would be similar to reeshau's - Even in the best of times, CRE generally has its own complexities and difficulties, and I'd say those are about 5x more than 'normal' right now due to what's going on with interest rates, debt markets, insurance rates, etc. There is a world of pain going on with, in some cases, equity being wiped out of deals entirely.

It's true that CRE gets the headlines during the good times for its nice tax breaks and big booms, but it is also a very cyclical industry and, unlike just being invested in the market, when the cycle is down and there is a loan maturity OR interest rates / vacancy rise, you can be put very quickly into a position of needing to put additional cash in to the asset (either to fund a cash-in refinance if the value has dropped at the time of your balloon payment, or to just fund the OpEx and debt service and keep everything afloat until vacancy and/or interest rates are reduced).

It will also complicate tax returns with a potential LLC holdco, a whole other layer of accounting for the building, depreciation, etc. etc. Not a huge deal if it's worth it to you, but it certainly does add a layer of additional 'work' to life where you may not want it.

On the other hand, if you have the funds and aren't opposed to a bit of on-the-job learning and growing (and mistakes - I and everyone I know in the industry have certainly made plenty), it could be a good time to buy with values compressed and with some sellers who no longer have the cash to fund their debt service in distress. I would recommend leverage no greater than 50% LTV so you put more cash in up front but have more of a buffer to weather the storms (lenders for CRE can be local banks, national banks, LifeCos, private debt funds... I would find a local mortgage broker and talk to them about pricing the deal for you. A lot of CRE mortgages are 3-5 years with a balloon payment at the end, where you'll need to refinance at whatever the current rate is at that time). Also take a look at rental rates, vacancy in the asset class and submarket that you're looking in - if the place is partially vacant when you buy, how long is it going to take you to lease it up? If a tenant leaves, how long will it take to replace them? Will replacing them require a large capital investment to fix/improve the condition of the space? Many office tenants expect a "TI" Allowance (i.e. tenant improvement allowance where LL improves the space for their needs) from their landlord, as well as potential free rent for a specified period of time at the beginning of the lease. What will the rental rates be, and, are they gross (you pay utilities) or NNN (tenant pays utilities)? Any major repairs, expenses looming? Etc. etc.

Thanks for the info, lots to take in here. 

The world of pain is something I'm hoping will get me a deal--stuff really doesn't seem THAT cheap to me right now, but I don't really have a good feel for comps, either for rent or for the purchase price right now.  I know in residential real estate, there's a bunch of rules of thumb (which are being blown out of the water right now).  Is there a rent to purchase ratio I should be targeting? Or should I instead be looking at ROI and cash on cash return?

I guess as far as the financing goes--I don't have a ton of cash just sitting, similar to most mustachians.  I've got a taxable brokerage account with about 100k in it, 500k in 401Ks, 200k in primary residence equity, and a rental with ~400k in equity.  Because of this, I'd really like to have as much leverage as possible so I can keep money where its doing work.  I get that equity is safety, but it does reduce my ROI significantly if I have to liquidate my other performing assets to make a downpayment. 

As far as ownership structure goes, is it similar to a Residential rental where there's no way I'll get a loan in the name of the LLC and I'll have to have the loan in my name?

I don't own CRE but I have looked at deals and have people in my circle who are CRE people. In pretty much any successful deal that I've heard about or gotten eyes on, it's most important that an underperforming asset is purchased, then value is added to the property. This could mean changing the building use entirely, building out space for tenants, unearthing use cases for higher paying tenants, raising rents to market levels, reducing operating expenses, or any combination of the above.

This is especially important because the bank values commercial property much differently than residential.

I also recommend starting to build relationships today with local commercial lenders. Get a referral for a commercial lender if you can. Then pick up the phone and call even if you're a year away from a deal. Call them once in a while and build the relationship. That way if the right deal comes up, you're ready to move on it and have your ducks in a row.

Yeah, the BRRR made famous by Biggerpockets seems like it could work in the commercial world too. 

As far as making relationships, I'm a little concerned about that.  It seems like every time I reach out to a real estate professional about anything I get bombarded with pressure to buy, even if I'm not ready.  I'd like to have some ducks in a row before going to a lender and making an ass of myself. 
« Last Edit: January 31, 2024, 02:09:33 PM by rothwem »

Archipelago

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Re: Commercial RE, anyone dabble in it?
« Reply #5 on: February 01, 2024, 09:56:07 AM »
Hi Rothwem - I worked in CRE and own development land, multifamily and office. My advisement would be similar to reeshau's - Even in the best of times, CRE generally has its own complexities and difficulties, and I'd say those are about 5x more than 'normal' right now due to what's going on with interest rates, debt markets, insurance rates, etc. There is a world of pain going on with, in some cases, equity being wiped out of deals entirely.

It's true that CRE gets the headlines during the good times for its nice tax breaks and big booms, but it is also a very cyclical industry and, unlike just being invested in the market, when the cycle is down and there is a loan maturity OR interest rates / vacancy rise, you can be put very quickly into a position of needing to put additional cash in to the asset (either to fund a cash-in refinance if the value has dropped at the time of your balloon payment, or to just fund the OpEx and debt service and keep everything afloat until vacancy and/or interest rates are reduced).

It will also complicate tax returns with a potential LLC holdco, a whole other layer of accounting for the building, depreciation, etc. etc. Not a huge deal if it's worth it to you, but it certainly does add a layer of additional 'work' to life where you may not want it.

On the other hand, if you have the funds and aren't opposed to a bit of on-the-job learning and growing (and mistakes - I and everyone I know in the industry have certainly made plenty), it could be a good time to buy with values compressed and with some sellers who no longer have the cash to fund their debt service in distress. I would recommend leverage no greater than 50% LTV so you put more cash in up front but have more of a buffer to weather the storms (lenders for CRE can be local banks, national banks, LifeCos, private debt funds... I would find a local mortgage broker and talk to them about pricing the deal for you. A lot of CRE mortgages are 3-5 years with a balloon payment at the end, where you'll need to refinance at whatever the current rate is at that time). Also take a look at rental rates, vacancy in the asset class and submarket that you're looking in - if the place is partially vacant when you buy, how long is it going to take you to lease it up? If a tenant leaves, how long will it take to replace them? Will replacing them require a large capital investment to fix/improve the condition of the space? Many office tenants expect a "TI" Allowance (i.e. tenant improvement allowance where LL improves the space for their needs) from their landlord, as well as potential free rent for a specified period of time at the beginning of the lease. What will the rental rates be, and, are they gross (you pay utilities) or NNN (tenant pays utilities)? Any major repairs, expenses looming? Etc. etc.

Thanks for the info, lots to take in here. 

The world of pain is something I'm hoping will get me a deal--stuff really doesn't seem THAT cheap to me right now, but I don't really have a good feel for comps, either for rent or for the purchase price right now.  I know in residential real estate, there's a bunch of rules of thumb (which are being blown out of the water right now).  Is there a rent to purchase ratio I should be targeting? Or should I instead be looking at ROI and cash on cash return?

I guess as far as the financing goes--I don't have a ton of cash just sitting, similar to most mustachians.  I've got a taxable brokerage account with about 100k in it, 500k in 401Ks, 200k in primary residence equity, and a rental with ~400k in equity.  Because of this, I'd really like to have as much leverage as possible so I can keep money where its doing work.  I get that equity is safety, but it does reduce my ROI significantly if I have to liquidate my other performing assets to make a downpayment. 

As far as ownership structure goes, is it similar to a Residential rental where there's no way I'll get a loan in the name of the LLC and I'll have to have the loan in my name?

I don't own CRE but I have looked at deals and have people in my circle who are CRE people. In pretty much any successful deal that I've heard about or gotten eyes on, it's most important that an underperforming asset is purchased, then value is added to the property. This could mean changing the building use entirely, building out space for tenants, unearthing use cases for higher paying tenants, raising rents to market levels, reducing operating expenses, or any combination of the above.

This is especially important because the bank values commercial property much differently than residential.

I also recommend starting to build relationships today with local commercial lenders. Get a referral for a commercial lender if you can. Then pick up the phone and call even if you're a year away from a deal. Call them once in a while and build the relationship. That way if the right deal comes up, you're ready to move on it and have your ducks in a row.

Yeah, the BRRR made famous by Biggerpockets seems like it could work in the commercial world too. 

As far as making relationships, I'm a little concerned about that.  It seems like every time I reach out to a real estate professional about anything I get bombarded with pressure to buy, even if I'm not ready.  I'd like to have some ducks in a row before going to a lender and making an ass of myself.

I think you'll find the commercial world a little different. Commercial brokers and lenders operate on completely different timelines. They have bigger lead times, sometimes a year out or more. It's also not uncommon to have 50+ page commercial leases. If you don't have a lender who's willing to work smaller deals or give you the time of the day, they're not going to be your best bet when it actually comes to closing a deal. In that case, keep looking. Don't be afraid to physically visit the bank either. CRE is definitely a relationship business.

Lenders know the difference between tire kickers and people who show up actually looking to put their ducks in a row. Those are their best clients to work with. I promise you will not make an ass out of yourself by getting ahead of the game speaking with a lender.
« Last Edit: February 01, 2024, 09:58:41 AM by Archipelago »

sayonara

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Re: Commercial RE, anyone dabble in it?
« Reply #6 on: February 01, 2024, 12:52:31 PM »

The world of pain is something I'm hoping will get me a deal--stuff really doesn't seem THAT cheap to me right now, but I don't really have a good feel for comps, either for rent or for the purchase price right now.  I know in residential real estate, there's a bunch of rules of thumb (which are being blown out of the water right now).  Is there a rent to purchase ratio I should be targeting? Or should I instead be looking at ROI and cash on cash return?

I guess as far as the financing goes--I don't have a ton of cash just sitting, similar to most mustachians.  I've got a taxable brokerage account with about 100k in it, 500k in 401Ks, 200k in primary residence equity, and a rental with ~400k in equity.  Because of this, I'd really like to have as much leverage as possible so I can keep money where its doing work.  I get that equity is safety, but it does reduce my ROI significantly if I have to liquidate my other performing assets to make a downpayment. 


With respect to the current prices - your observation is what we've seen as well - Sellers aren't willing to accept prices lower than 2021 values, even though values have likely come down substantively since then. So, if they can, they're continuing to hold until pricing rebounds, despite thin-to-negative returns. Buyers aren't willing to pay 2021 prices because that would result in negative cashflow, so the market is generally pretty stagnant except for assets that have defaulted and are in receivership. The market is broadly expecting significant distress in 2024 and 2025, but that has yet to truly materialize as of yet, despite some high profile bankruptcies.

For returns, the metrics are typically ROI and COC returns, like you mentioned. With interest rates where they are, COC returns are (generally) in the low single digits (below Treasury yields) in most markets. Of course, as it sounds like you're in this for a longer duration and it also would save office rent for the side gig while you're at it, those COC returns are likely to rise in the future for you assuming interest rates have peaked and no other significant issues with the building/submarket.

As far as ownership structure for this type of asset, I'd say it's quite common for the loan to be in the name of the LLC with the asset as collateral and with no personal guarantee from the LLC member(s). It'll likely be specific on the asset type, LTV and such.

ChpBstrd

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Re: Commercial RE, anyone dabble in it?
« Reply #7 on: February 12, 2024, 11:17:39 AM »
Just going to double-check you've thought outside the box a bit:

1) Does the side hustle 100% require an office? If the work can be done from a spare bedroom, it's tax deductible. Would a nicely finished backyard shed suffice? Do you have friends with spare space and a need for cash?

2) Have you considered subletting a room in someone else's office? For example, a friend of ours has a gift shop in space she shares with a law firm. Other possible sharing opportunities include real estate agents, insurance agents, industrial companies, appraisers, inspectors, financial advisors, cosmetics salons, dedicated co-working spaces, and restaurants/bars/shops in historic parts of town with unused upstairs space. This is essentially a marketing question - can a person in this line of business get away with sharing space, or does that look sketchy for the type of work being done?

rothwem

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Re: Commercial RE, anyone dabble in it?
« Reply #8 on: February 12, 2024, 11:56:30 AM »
Just going to double-check you've thought outside the box a bit:

1) Does the side hustle 100% require an office? If the work can be done from a spare bedroom, it's tax deductible. Would a nicely finished backyard shed suffice? Do you have friends with spare space and a need for cash?

2) Have you considered subletting a room in someone else's office? For example, a friend of ours has a gift shop in space she shares with a law firm. Other possible sharing opportunities include real estate agents, insurance agents, industrial companies, appraisers, inspectors, financial advisors, cosmetics salons, dedicated co-working spaces, and restaurants/bars/shops in historic parts of town with unused upstairs space. This is essentially a marketing question - can a person in this line of business get away with sharing space, or does that look sketchy for the type of work being done?

Good questions.  She's meeting with clients that are more or less strangers, it'd be weird to have them in our house I think.  Currently she's meeting in libraries and coffee shops, but since she's only at it a couple times a week its no big deal.  If she wants to scale, I think she'll wear out her welcome pretty quick in a public space if she's there every day. 

Subletting could be an option though, if the attached business is right.  That's what got me started down this rabbit hole though, the rent for space seemed pricey for what we got, and I started looking at buying, and now we're here. 

We're going to try to keep this pace for 6-8 months and see how it goes, whether she wants to expand or not.  It might be good to just keep it light for a while. 

clarkfan1979

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Re: Commercial RE, anyone dabble in it?
« Reply #9 on: February 12, 2024, 01:50:40 PM »
My wife started a side hustle recently that is killing it--its already making more than her day job after a month.  We're going to continue on our current course for 6-8 months or so before we make any moves, but in order for her to go full time on the side hustle, she'll need some office space.  I started looking around at commercial RE, and renting an office seems like a really bad value, its thousands of dollars a month for a simple office suite and its not like the landlord really does anything to fix the building--paint, carpets, light fixtures, etc are all on the renter. 

I was considering just buying a commercial building, renting out an office to her business, and finding tenants for the other units. 

The problem I have is that I have zero experience on the commercial side of real estate.  I've got a duplex that I've rented out for 10 years, but residential is a different world from the commercial.

Anyone own a commercial building?  How's it going for you?  How did you get started, and what kind of financing did you use?

I would rent a commercial space for 12 months first. If it goes well, then maybe buy a commerical building. Buying a commercial building right now seems a little early. Commercial can be very niche and will probably require more time to understand and process. The fact that you cannot get fixed long-term debt on commercial is concerning to me. It's not that I won't do it, but I need to make sure I have done all of my homework before pulling the trigger or having massive reserves to afford costly mistakes. 

ChpBstrd

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Re: Commercial RE, anyone dabble in it?
« Reply #10 on: February 12, 2024, 03:13:01 PM »
I took the car out for a rare drive this morning and noticed a couple of small strip mall style office/retail properties with gigantic for sale signs and price reduction signs added to those signs.

Not sure what the bottom looks like, but I can imagine it getting worse. To catch a bottom in stocks or real estate, you must catch a falling knife.

rothwem

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Re: Commercial RE, anyone dabble in it?
« Reply #11 on: February 13, 2024, 06:34:16 AM »
I took the car out for a rare drive this morning and noticed a couple of small strip mall style office/retail properties with gigantic for sale signs and price reduction signs added to those signs.

Not sure what the bottom looks like, but I can imagine it getting worse. To catch a bottom in stocks or real estate, you must catch a falling knife.

Yeah, I totally get that. I guess what Iím trying to leverage is the relatively stable rent prices compared to volatile purchase prices. Iím not trying to capture the bottom of the market, Iím trying to find value. Itís more complicated than I thought though so Iím going to put a pin in it for a bit, I need to raise capital anyways.

I should network a bit though, maybe try to find a commercial lender like @Archipelago suggested.