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CRE Transactions vs. Residential Transactions

June 15, 2018

The complexities that make them different … and similar

In a market like South Florida, where cranes are a part of the skyline and neighborhoods are routinely undergoing transformations, it seems as if there’s an investment opportunity on and around every corner. Before signing on the dotted line, though, there’s a lot to think about – because not all investments are created equal.

When considering a commercial real estate investment or a multi-unit residential investment opportunity, it’s important to consider that each transaction has its own unique complexities, as well as some similarities.

Income stream vs. bricks and mortar

Taking a page from Real Estate Investment 101, the purpose of investing in any sort of property is to generate profit or income. It’s the income stream that’s essentially being purchased in a commercial real estate investment. The bricks and mortar of the property just happen to come along with it.

As a result, it’s important to underwrite the integrity of the current income stream or the potential income stream that could come from that investment. This in and of itself contributes to the complexity of a CRE investment. Two examples better illustrate this idea:

CRE Example 1

You’re interested in purchasing a triple-net investment; a free-standing building that’s currently home to a CVS Pharmacy. With the reputation of its brand, you generally have a sense that CVS is a very strong, credit-worthy company and the risk associated with the tenant is not that high. In other words, you’re likely to get your full income stream remaining on that lease.

CRE Example 2

Now, let’s up the complexity factor – and risk – with the purchase of an office building that has 27 tenants. As an investor, you have a responsibility to read and investigate every lease, as well as know the length of each of those leases, the average lease term on the rent roll, and see how creditworthy each of those 27 tenants are. The findings of this sort of research will help you establish the risk related to that investment. This same due diligence is required for retail and industrial investments, as well.

Residential Example

This doesn’t mean that residential investment opportunities are not concerned with risks or income streams, or that they are “easier” than a commercial investment. In fact, they are uniquely complex because of the nature of the residential tenant.

First and foremost, residential tenants move frequently. It’s generally safe to assume that one-third to one-half of your tenants will move out of your investment property. In a building with 30 rental units, that number translates into 10 – 15 vacant units at any time. As a result, you will have to figure out what your capital expenditure will be to replace those tenants, as well as how to maintain a profit while those units are vacant.

Additional complexities to investment opportunities

As different as residential and CRE investments may be, they also have several items in common — which can add more complexities to the mix:

  • The condition of the property – whether it’s commercial or residential – will have to be maintained or improved;
  • The integrity of the rental income must be fully explored and understood;
  • Leases can quickly become more complex, especially when it comes to delineating who is responsible for what, such as maintenance, security, and technology;
  • Federal and local laws are an additional layer of the equation, and it is the owner’s responsibility to be in compliance with existing laws or those that change. This can especially difficult when investing in properties in various locations. What works in one county may not be allowed in another.

One simple solution in one location

At the end of the day, it may be beneficial to consult with or hire a qualified professional who is adept at navigating investment waters. The professional team at Morris Southeast Group is skilled at property management services and investment due diligence. Our comprehensive services include owner and tenant representation, marketing, lease administration, collections, and financial reporting.

For a free consultation or to learn more about our property management services, current investment opportunities, and/or other services, call Morris Southeast Group at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

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