Differences Between Residential and Commercial Real Estate
Welcome to wealth chakra. This is Ike Mutabanna. Wealth chakra, you know, as I’ve spoken to a lot of you who might be watching this video, and many of my investors over the past several years, it’s a platform that I’ve been working on very slowly, very cautiously. The idea is to build an educational platform that’ll help everyone who watches it, and becomes part of our community to really learn about commercial real estate investing, become involved in understanding it, and being part of it. And hopefully, you benefit from it in a multitude of ways. And then we’re
here now, where I am in conversation with Shreya Agarwal, who is a up and coming, brilliant,
and, a passionate, new real estate investor in this market, so, turning it onto you Shreya.
Thank you. Hi, everyone, my name is Shreya, and I’ve just graduated from Boston University. So I really want to get people that are in my generation more involved in real estate investing, and help them understand the benefits of it long term. Because, as I grow older, I just realized that time is the biggest asset that we have. Money can always be, be, accumulated later. But once that time passes, it’s gone forever. And so I’ve been in conversation with Ike for the past two months. And I myself, I’ve been starting investing in duplexes, and like starting small scale, and so I really am, grateful to have this opportunity to help educate the larger audience in this type of educational platform. So, with that said, I’d like to kick this session off with talking about the different types of commercial real estate, there are so many things, of course, Ike you specialized in multifamily, but there’s, office and industrial and retail, and the list goes on. And so I just wanted to see, if you had some insights on, we can just start with, multifamily, because that’s what you are specializing in, and then we can maybe just go down from there, into the different types of commercial real estate.
But I think maybe what we should do also is maybe take a step back one further step back, and really talk about the difference between residential and commercial real estate, because I think what I find is in many conversations I’ve had with investors, that is, in fact, a point of confusion. Right. And to some extent, you and I had a discussion about that when we first started talking, right? Yeah. What makes something commercial versus residential? There’s no real nomenclature that is standardized, and blessed by any particular authority to say, what, what’s one or the other, right? It really is very contextual. And it really depends on in what who is what are you referring to. So let me give an example. You buy a house in which you’re going to live, by definition that’s residential, in fact, is referred to as single-family residences, right? Now, it may be a townhome, it may be a condo, but it’s a house in which you’re going to be living. Even when you sign the loan, you’re going to live that that’s going to be a primary residence. So by definition, anything you live in is residential. But then a few caveats start coming in. And one of them is what is the intent of buying that property? If the intent is to make income out of it, not strictly for you as the owner to live in it, then potentially that could be considered commercial because commercial by very simplified definition is anything where you make money and run a business. Right? So then the question comes is if I buy a single family house, and I put it on rent, is that commercial? Well, in a very simplified sense, yes. Yes, it is. Right? But then, from more of an industry law perspective, it’s not just because of the fact that it the industry looks at things commercial. When, number one, there is no other use other than making income. Number two, that there is potential for scale. Right? When you buy a single family house, it is always going to be one single family house. It could be used for doing a rental. Or it could be where someone could go and live, like as new yourself could live as an owner. Right? When it changes hands, that use could change, you might buy it as an investor to put it on brand. You sell it and the person who buys it from you could go live in it. And now it’s no longer commercial. Right? Right. So when that kind of ambiguity in usage happens, it strictly would not be considered commercial. Okay. The other thing that also plays a role is how do the banks look at that property? Because there’s
the four-plus units and how that changes? Yeah,
the banks have their own definition. The banks, when they give you what is called a conventional mortgage, that is what you get for anything that is considered pure residential, regardless of whether you’re going to use it for it, or rental property or not. And in a very, again, a simplified fashion, most banks, when you own a property that has four units or less. And by unit, I mean, each individual entity, right? Yes. One set of people live
in? Yeah, it’s not it’s not a room. It’s like an apartment.
Exactly. So for example, if you bought a house with three bedrooms, and you put two of them on Airbnb, that doesn’t make it commercial, right? Neither does the bank considered commercial. Because you’re still in a single unit. It is still where you’re living, or maybe you’re putting it out brand, but the usage could change, and you still get it on a conventional mortgage. So a property which has one unit, that single family residence that has two units, maybe a duplex, three units, you know, triplex which is very not as common. Yeah. And then a quad Plex, which, you know, depending on the market can be quite common. Right. So, up to that point, you could be putting these on rent, right, the banks will still only give you a conventional mortgage now, because of these rental properties. Yeah, you will end up paying a higher interest rate, even if it’s a conventional mortgage. Exactly. Because living there is no risk is higher. Yep, yeah, the risk of the bank is higher, right. But the moment you cross it to five, and plus, at that point, the bank start looking at that as truly being commercial as in business only, when there is no potential for that to become the primary residence, even partially, right. I mean, it could be, but for the banks, the way they underwrite these things, they look as five plus as being purely commercial intent. So in the residential space, which is in the space of properties, where people go and live, the four, number four is the defining factor. one through four is considered residential from a business perspective, and a debt perspective. Five plus starts getting treated as commercial and therefore becomes called as commercial real estate, even though the intent is residential. Right, even though there are people living in it, so yes, that is why I was on a call actually an investor just about a month ago. And I kept talking and kept saying commercial real estate, and I kept talking about multifamily. And after a point, he stopped me saying, I’m getting really confused. You keep talking about people living there, but you keep calling it commercial. Yeah. Because in his head only thing that’s commercial is, you know, the retail store offices and that kind of thing, this, is the only space that is ambiguous, and you need to understand what makes it commercial and what doesn’t. Yeah, the moment to talk about other types of real estate. They’re by definition commercial because they only have business intent. There is no other use.
Yeah, so I’m curious to know, I think that’s a great distinction, but you specifically chose to go into multifamily. Was there a reason that looked at multifamily?
I was and I, I will tell you, I think for each person, the argument, the definition can be a little bit different on why they chose a particular specialization within commercial real estate. And there’s very good reasons to do the other forms of it. Right? For me, when I was thinking about it, looking at all of it, I am involved in other types of commercial real estate, why I chose to specialize in multifamily is it’s a very simple thing. I looked at two things, I looked at what I consider as an essential service. Okay, I like to invest in businesses that are, tend to be essential services. Yeah. And in the real estate, space, housing is an essential service, people always need a roof over their heads, doesn’t matter what happens, right? When it comes to food, rather, when it comes to shopping, right, things can change, they can go from being in the retail store to going online. When it comes to, manufacturing, it could happen in the factory here, the factory could move, right, and those jobs with it, it could move offshore, it could move within the US somewhere else. When it comes to even distribution, for that matter, you could have a warehouse here today. And the next thing you know, the supply chain of the company changes and it says, I no longer need a distribution hub, do I need it here? And that changes, right? However, anywhere people congregate anywhere people exist, housing is required, I need a place to live. So in fact, in Hindi, you know, we have from Indian origin, there is a saying about what is the essential thing in life is roti kapra, aur Makaan, which means, food, clothes on your back, and a roof over your head. Now they’ve added a fourth one call into that, but it’s still those three essentials. And even within those three, if you think about it, you can survive with the same set of clothes forever if you need to. Yeah, I mean, they might get in tatters, you could survive by in terms of food by cooking yourself and you know, not going out to eat and all that. But housing, what are you going to do? Right? There’s a choice between being having a roof over your head and not having and no one’s gonna choose not to have that. So yeah, just because of the essential service of nature of that particular form of real estate. To me, I felt the risk mitigation levels went down dramatically. And it ended up getting proven during this pandemic period. Right, where offices went virtual, and many of them shut down. Retail got shut down during all the lock downs, and really struggled to come back. A lot of them have not yet. Right. Probably industrial is one of the few ones that actually did well. And again, it’s sort of certain types of industrial, the ones that are involved with ecommerce supply chain,
everything. Yeah, all the all of the online relevant Shopify increase their business, I think multifold and is now trying to copy that Amazon distribution, logistics, infrastructure. So yes, industrial is probably one of the few ones that did well, the same time industry is also what did not do well, 20 years ago, when a lot of the manufacturing facilities started getting down winded. Yeah. And things get a shift abroad.
Okay, so question on that, actually. Because I’ve thought about this, and I don’t really know the answer. If say there’s, a strip and they’re maybe five or six tenants in that shopping strip, but they sign a 15 year lease, right? Because most of these leases aren’t going to be like, one to two years, they’re going to be long term lease, you’re gonna walk down, the rate and stuff. So if there is something like COVID to happen, can they get out of the lease? Like, I don’t know, it’s kind of a vague question.
yeah, it’s a very good question. So I’ll tell you what, what I saw happen firsthand, during this, right. A lot of the offices and retail properties that were leased out on multi year leases, yeah. The biggest difficulty that the owners had was then those if it was just, you know, triple net leases,
triple is basically where the tenant really practically pays for everything they pay for taxes, they don’t pay for all the capital expenses,
they pay for, like some repairs and stuff. But the rent is obviously way lower than the negotiated rent,
correct? Correct. But it’s pure profit at that point. Your gross income is basically the same as the net Right. So it also reduces the hassle for the property owner completely. Now, what happened was because of this issue with the pandemic, and all these shutdowns, a lot of them went back to the owners and asked for a renegotiation where either they wanted out of the bliss altogether. Yeah. Or they basically said, hey, put us on pause for some time, or give us a break on the ramp. And we’ll still pay all the bills, but don’t charge us anything more, because we were not making enough business to justify that. And that obviously causes a lot of distress for owners, right. There are some that think of the hospitality industry, right, hotels went empty for months. And some of them survived, you know, simply through their, whatever capital, that they hadn’t reserved. Some of them survived, you know, when they were able to get onto a government program, where hotels were included in this program to help turn them into temporary, yeah, temporary, COVID testing and that kind of stuff. But to a large extent was hospitality had a very tough time. So having leases by itself doesn’t protect you, even if a lease is three years, four years, five years long. It doesn’t protect you. When something happens, okay, what it does do when things are normal, is it reduces the overhead for you to have to find,
yeah, but it’s not binding, but if something like this happens, what can you dispute it?
What can you do? I mean, the worst thing you can do is to evict them, and what? People from an office complex, you still have to go out and get new people willing to? Yeah, where are you going to get them?
Yeah. Okay, that’s fair. That makes sense. Yeah.
So what else? What else would you like to know about?
I think this can be like a different topic. But I’m really curious to know about whether the loans differentiate with multifamily. And with, with strips versus office versus, of course, there’s like so many different kind of loans, and, bank and then conduit that hard money lenders, and then of course, you know, what you do is like syndication and then with private money, but is there some sort of like general rule of thumb that, this institution really prefers to give loans to, you know, just industrial warehouses or self storage’s? Or is there some sort of like norm in the industry?
I think there isn’t, there isn’t a normal in terms of who will give loans to whom? Well, it really depends on the lending institution. Bank usually has its own criteria, yeah, on where the loan money is going to flow. Right. Banks, for instance, who will only loan money to retail, there are some who will only loan money to industrial, there’s some who will only loan money to new development. I mean, forget about, you know, what the final asset type is going to be. I have met just bankers who will only loan to brand new development. Right. That’s what their risk profile is. So it really depends on each lending institution to to figure out what they’ve decided is their risk versus reward profile? Yeah, who they’re going to lend to. Okay. Now, in the multifamily industry, what really helps is the presence of Fannie Mae and Freddie Mac, okay. Right as, as two agencies that provide, they probably provide 80 to 85% of all the debt that flows in the multifamily industry. And they provide very stable kinds of debt. And the reason for that, and there’s also hard, you know, the Housing Development Authority, they also provide that as well. The debt that comes from these agencies is what is called as purpose-driven debt. Right? Because, they are serving a public purpose when they give debt. And one of the core public purposes is housing. So the type of loans you could loan products you
get from the agencies, these federal agencies can be very beneficial, depending on the market cycle, and depending on the nature of the product you’re buying, and you know, what you intend to do with it? Okay, um, generally, if you’re buying properties that are a little bit older, or lower in their quality level, and your business strategy is to improve their quality. Yeah, that serves the mission of these agencies to improve quality of housing. Okay, we tend to get good loan proceeds from these agencies for that type of project. Some of the projects that we do, especially the ones we’ve been doing recently, are brand new construction projects, we don’t construct them, we buy them from the developer, okay. And we have a different business strategy behind it, it doesn’t serve the purpose of these agencies, because it’s not,
because there’s no other value to be created, right, if the housing
is already there, so there is no mission that they can support for that type of housing, which is why we get less interest from agencies for this kind of project that we’re doing these days. Right.
Okay. Okay, so follow up question to that, is there a general norm, like, this is going to be the, you know, the risk for, for an office building, that’s just gonna be maybe five, five or six offices that is higher than the risk of an industrial, you know, manufacturing? Does that really depend on the location? Or the person that’s doing it? Or does that
the location and the period of the market? Okay. Yeah, as I said, right now, if you compare
office versus industrial, I will tell you industrial is the way to go?
What about all things equal? Like, all that, you know, same location, same time period? You
know, I’m just trying to help maybe our listeners kind of get a gauge of what they should invest passively in, right, like through, even a syndication or fund just every month, but just all things equal, same location, same time period today, what would be a higher risk, high reward
Very general question. I really cannot answer that trail for the simple reason that real estate is an extremely localized type of business. Right? You cannot have a rule of thumb saying, if all things are equal between three different asset types, what did I invest
in? It doesn’t work that way, because all things will not be equal. Right? They just cannot be it’s not possible. Right, your loan terms will be different. From a location perspective, the value of that location is different depending on what it is, for instance, if you think of multifamily, right, in multifamily, the location really matters in terms of what are the economic opportunities in that economic area? Right, people who live in an apartment complex, you know, would be willing to drive 20 minutes for their place of work to find employment. At the same time, you also want to see what other multifamily exists in a three-mile radius, because that is the choice. They’re making a choice of location based on school district, or based on amenities or based on facilities and an access to shopping. On the other hand, when I want to go and put some stuff in storage, okay, right. So self storage, or storage units are a type of industrial property. If I have to go to stock put stuff in storage, I am not going to go five miles or 10 miles away. I’m going to look for convenience, I’m going to look for a self storage or a storage unit. That is within one, two, maybe three months, at the most. Yes, I want easy access to it. So the nature of the asset type and what is available in that area, and what my intentions are, as the consumer as the tenant as the leasing whatever makes a huge difference. So I don’t think anything can be considered apples to apples. Right? Okay, if you ask me within multifamily, yeah, either Class A and Class B. Everything else is the same. Right? With 10 up again. Okay, maybe it’s the same, maybe it’s not, it’s not the same, because what is not going to be the same as the type of people who live in those two assets. Right? People who live in class A assets really choose to go and live there because of the luxury amenities. And they prefer doing that rather than living, going and buying a house where they can get the same level of amenities. People who live in Class B Class C type of properties are really people who are typically in the demography, that they live in apartment complexes, and are not likely to be able to, go forward. Anything else? Yeah. So that also changes how you look at those properties, even if they’re in the same location.
Yeah. No, I think that’s fair. And I think this has been really educational for me. You know, I know we’ve talked a lot about this stuff, but I think actually delving into it has been eye-opening. But I think, the next time maybe we can talk about because if we talk about class A Class B, then this is going to be like another 30-minute conversation with you, I woud also want to dig deeper on, the valuations with these different types of assets probably in the next video. But yeah, this was great. This was really helpful.
I’m glad you enjoyed it. And I hope our audience who’s watching this listens to it will get something useful out of it
Yeah, yeah, I’m sure they will. All right. All right, wonderful.
Well, let’s come back the next time and I think you wanted to talk about valuation of property.
I think that would be a really good topic to delve deeper into. Yep. Let’s do that. Okay. Thank you so much. Bye bye.