5 reasons real estate investors stall out in Residential (and never make the jump to Commercial)
Updated: Mar 11, 2019
Why is it that most real estate investors stall-out in residential and never make the jump to commercial? Well, Jennifer and I made the jump and lived to tell the tale and I’d like to explore the question.
Looking back to when we were first getting into residential investing, it’s odd how fearful we were about the whole process. The industry lingo, the analysis, the acronyms, the social stigma, the constant nay-saying from most folks in our personal/professional networks...the list went on.
Fast-forward a couple years and there we were, eye-balling the amazing opportunity sitting just slightly “up market” in commercial multifamily real estate. Just like last time, we felt rattled by the learning curve and the same fears that struck us early on were rearing their ugly heads once again.
By the time most folks have invested in their first rental property - typically a duplex or single family - they’ve already faced-down the common stigmas of real estate investing. You know the culprits:
“... too risky…”
“... too much work…”
“... I don’t have enough experience...”
“... not enough money…”
We went through the same comfort zone expansion that all investors go through. College educations and 10+ years corporate careers didn’t adequately prepare us for the intellectual/emotional challenges involved with buying those first properties. The onboarding process is even tougher because of all the un-learning involved. Most mainstream investment education out there these days virtually thrusts all of us toward Wall Street investment vehicles (e.g. 401k’s, mutual funds). Along with that one-sided education comes deliberate Scarlet-Letter-branding of real estate.
Enter, commercial real estate investing. By the time we had committed to focusing on multifamily commercial properties, you would think that the knowledge, experience and confidence gained from winning in residential real estate would prepare us to boldly leap in, head first.
Maybe the more adventurous folks out there are capable of that the “ready, fire, aim” approach. Jennifer and I, on the other hand, are the “ready, aim, aim, fire” types of professionals; operations junkies…process nerds.
To get comfortable with commercial, we pressure tested each of the big stigmas that we were experiencing all over again. I wanted to know if they were legit. Here is where we landed:
#1 - Risk
At the time of our first residential deal, taking that first jump felt incredibly risky. And it was. We had a duplex that was half occupied. 50% of our potential income was a big goose egg. Now, while we prepared for this in our modelling, it still didn’t sit well as we felt that looming negative impact on the bottom line.
Here’s what we realized when we started evaluating commercial investing:
Smaller = riskier
Larger = predictable
You can mitigate it by vetting the operator and the deal. Commercial operators and deal structures tend to work more like a true business, compared to residential. The caliber of people you work with, planning rigor and historical risk-adjusted performance of the asset…all add up to an investment vehicle that is more predictable than residential real estate.
#2 - Effort
It takes a lot of effort to find, analyze, negotiate, finance, vet and close a property… regardless of its size or number of units. What we learned was “economies of scale” is a key benefit of commercial multifamily investing. This means that you’re putting in roughly the same amount of work to buy many “doors” on a commercial deal as you’d put into a small property, with as little as one “door” (in the case of a SFR). Whether it’s a single family rental or a 100-unit apartment building, guess what?
You are doing analysis on 1 property, in both cases
You are negotiating with 1 seller, in both cases
You are securing financing for 1 property, in both cases (if you’re financing)
You are signing 1 set of closing docs, in both cases
#3 - Experience
This is a big reason why people never take the jump into commercial. You’re up against people who have been doing this their whole careers. How could you possibly compete? Here’s the simple answer:
You can borrow experience by partnering with experts
Most experts are generous and eager to help newcomers, as long as you add value by offering them something they need (most times it’s grunt administrative work). The only three barriers-to-entry on the experience front are:
Courage: Willingess to put yourself out there and occasionally sound like an idiot in the service of learning
Humility: Self-awareness of your shortcomings. Learn enough to know what you don’t know, so you approach proven operators with the appropriate level of respect and humility
Contribution: Find a way to add value. No one owes you anything. Successful investors are busy and their time is worth more per-minute than the vast majority of other professionals in the working world. If you find a way to work with others in a mutually-beneficial way, you unlock a larger network of potential partners.
Experience is gained with practice and failing-forward, but most commercial real estate investors are happy to partner with newcomers if you approach them with these three considerations in mind.
#4 - Too confusing
Have you Googled “real estate investing?” There are hundreds, maybe thousands of resources available to help you climb the learning curve. Pick your poison: podcasts, books (audio/written), local meet-up groups, forums, coaching programs, classes, conference, etc. Initial confusion is understandable. Reach out and I’m happy to share some of the resources we find helpful.
The most common reason for slacking off on the commercial learning curve is a lack of time. I can speak from personal experience that anyone can find/make the time to listen to an audiobook or a podcast amidst a busy day. If you’re running errands, exercising, cleaning, commuting… you have untapped learning time. It helps to start by taking stock of your calendar and finding those opportunities.
#5 - Not enough capital
This is the ultimate showstopper for most folks. It was for us as well, at first. “We don’t have enough money to do that!”
There’s an amazing habit that I picked up throughout the learning journey over the past couple years. I can’t fully remember which specific book or mentor taught this (probably because it’s so ubiquitous in the investing circuit), but it goes like this:
Scarcity mindset: “that’s a great looking property. Returns on the deal look amazing. It costs how much!? We can’t afford that.”
Abundance mindset: “that’s a great looking property. Returns on the deal look amazing. It costs how much!? How could we afford that? Let’s figure it out.”
The difference may seem subtle at first, but the results are massively different. Ultimately, it’s better to get 50% of an amazing deal by partnering with someone else and splitting the profits with another investor vs. get 0% returns by never doing the deal in the first place. #PartneringWins
Investing in syndicated commercial deals allows newcomers and experienced investors a way to get amazing returns, learn fundamentals of real estate investing and put virtually no work in during the process. It’s one of the only truly passive investments available.
Flashback 10 years ago, if we had known then what we know now, we would have bypassed residential investing altogether and jumped into commercial investing as passive investors. We would have done all this while working our corporate day jobs. Luckily, there are deals available…even now. Are you going to make the jump?
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Disclaimer: This article is intended for educational purposes only and does not constitute investment advice. You should always contact a registered financial professional before acting on this, or any advice. I am not a tax advisor or financial planner. This article represents my opinions.