Large commercial properties provide the opportunity for incredible profit. These properties can also be intimidating. But the high purchase prices limit competition to investor grade buyers who are going to use investor grade calculations. When properly managed, the function of scale keeps costs low and income high. But like every other type of deal, it’s important to weigh the pros and cons.
Five years ago I was approached by an investor looking for partners on a large apartment complex.
The property consisted of 220, one to three bedroom apartments spread throughout 10 buildings on a 15 acre “compound” in Delaware. None of the buildings were occupied, but over 90% of the units were in rent-ready condition.
At the time, this sized deal was over my head. The investor was attempting to raise $2.5 million for the purchase of the building, improvements and necessary overhead and carrying costs to get the building occupied. While the returns were promising, I passed.
Last week I got a call from the same investor. He told me about a similar project he was currently raising money for. Since that call I’ve been debating the pros and cons this new project presents.
If you’ve spent any time in the Real Estate Investing world, the chances are that you’ve come in contact with some unsavory characters. Any field that presents the opportunity for high profits will attract those people who will scheme to make a quick buck at anyone else’s expense. I’ve unfortunately learned this lesson personally on more than one occasion.
I’ve taken strides to ensure I’m never taken again. Among my many precautions, I’ve developed a need for control. If I’m in charge of who gets paid, when and for what, there’s a very small chance I’ll be taken advantage of.
Control is one luxury I will not have with this large apartment deal. I’d be a small owner of the complex. While I’d like to put up the entire $1.5 million needed, the fact is, I just don’t have that kind of cash lying around. Even if I did, I’m not sure I’d want to sink so much into one project.
My lack of control on the project is a definite con.
If you own a single family investment property, there’s one point of income. The ability to successfully collect that income (rent) from a tenant has a major impact on the cash flow of the investment. Moreover, if that tenant refuses to pay, it’s going to have a major negative impact on the success of that investment.
That’s one reason I love multi-unit buildings. If I have to kick out a tenant or an apartment is vacant for a month or two, I’m not reaching deep into my pocket every month to cover the mortgage. In fact, the larger the building, the smaller the impact each unit has on the overall bottom line.
The cash flow of multiple units is a major pro.
Functions of Scale
There’s a reason Walmart sells products at prices cheaper than anyone else. They buy more units of that product than anyone else. Manufacturers can afford to make smaller margins on one product because they know they’re overall profit will be much higher with larger orders.
The Walmart principle applies on large apartment buildings. From management to maintenance, the costs per unit go down once you can reach the pivotal function of scale.
As an example of a function of scale, let’s look at property management. Hiring a property manager to oversee a few single family homes is going to be expensive. Usually the cost will range from 6% – 15% of the rental rate. But for larger buildings, an in-house management staff can cost only a fraction of the cost.
Function of scale for this type of project is a major pro.
Return on Investment vs. Risk
The risk versus reward calculation is different for everyone. A professional gambler will certainly have a different comfort level for risk than, say, a teacher or an engineer. It’s important to determine beforehand what you’re willing to loose in a transaction before looking at the potential gains.
I wrote an entire blog post on this conflict a few weeks ago (you can click here to go to the post). So I won’t concentrate too much ink discussing this topic here.
Traditionally the risks in larger buildings are limited compared to those faced in a single family investment (if you’ve done your due diligence and bought at the right price).
In this case, the project is well below my risk threshold. ROI is a pro.
While large multifamily investments can be intimidating, they offer a great potential for profits. The large scale can offer insulation from risk as well as controlled costs.
My mind keeps returning to that investor phone call from last week. The pros certainly out-weight the cons. It looks like I need to spend some serious time considering the offer.