by: Colin Dubel, Charter Capital Group
Consolidated Costs: Apartment properties are a great example of economies of scale. All of your costs including maintenance and repairs, landscaping, waste removal, and cleaning are lower on a per-unit basis compared to SFRs. Having shared common areas and expenses is like buying in bulk at Costco. The bill might be larger, but is saving you money at the end of the day. Professional management on apartments typically charges less, allowing you to affordably concentrate on other things while they take care of your property. All around, just plain efficient!Less Risk: The stock market isn’t the only place it’s smart to have diversification. One tenant moving out of a 10-unit complex is going to hurt a lot less than one tenant moving out of your SFR. It costs less to find new tenants, costs less to turn an apartment, and takes less time to replace that tenant. The market for renters looking for apartments is also much larger than renters looking at houses. Apartments historically do well no matter if we are in a strong market or a down turn; people always need an affordable place to live, right? Apartments also offer less competition and are a more attractive asset class to buyers down the road.
More Value-Add Opportunity: Apartment properties are not as dependent on comparables as SFRs. The value will be more based on a multiple of the net income for the property, which you control for the most part. Increasing rents to market, finding savings on expenses, adding value-add amenities and making property improvements, are all steps that will improve cash flow and your property’s value. That larger property will also have a greater net appreciation. 10% appreciation on a $500,000 SFR will add $50,000 in equity, while 10% appreciation on $1M will add $100,000 in equity.
Your Lender Likely Won’t Be The Local Bank: Residential real estate lending is narrower in definition and has become very standardized, while commercial lending requires more specialization since it spans everything else that isn’t residential. Every lender is going to have their own appetites for certain property types, and their own tolerance for various property and borrower issues. There is no guideline available to determine eligibility, as these lender parameters are consistently changing and often times negotiable based on a number of factors if it makes sense for the lender. The market for your commercial loan also expands beyond your local bank. Often times, the best lending opportunities are offered through life insurance companies, CMBS conduit lenders and non-bank commercial real estate lenders. Traditional banks will have commercial real estate loans as part of their line of services, but many times lack the specialization to be able to offer the most competitive terms. Additionally, bank underwriting standards are traditionally more conservative and often cause more issues than they are able to solve.It’s More About the Property, Instead of You: While a lender will check to make sure a borrower is creditworthy and financially stable enough to qualify for their program, most of the analysis is actually on the cash flow and stability of the property. Lenders want to know if the predictable income of the property can support every monthly payment, and minimize any risk that might affect the borrower’s ability to meet that obligation. There is simply more risk in commercial real estate. If you had to make one payment between your family’s home and your retail investment property, which one would it be? The scope of analysis on a commercial loan will be broader, and encompass an examination of the market, tenant analysis, inspection of the property and other related surveys to uncover potential risk. All metrics used by the lender to determine your loan terms are based completely on cash flow.Terms and Costs Won’t Be the Same: You will not be able to get 10% down and a 30 year fully amortized loan, they just aren’t available. You should expect to put 25 - 30% down on the investment, and that’s if the cash flow can support the loan amount. A commercial loan will typically be fixed for a maximum of 10 years, and roll to an adjustable rate based on a financial index. The third party fees on a commercial property will also be higher, as the scope of work on items like the appraisal and inspection are more complex and time intensive. In regards to prepayment, you typically do not have the privilege of paying down the loan whenever you wish. Especially if the loan has been packaged and sold as part of a security, there will be a penalty fee upon repayment. Rate will also typically be higher, but determined based on a number of various factors related to both the property and the borrower.