Who or What Makes the Best Tenant?

When you think of commercial property, you probably think of tall skyscrapers, office buildings, and warehouses. But what about large apartment complexes?

If you ask any banker, he’ll tell you that a building with more than four units is considered a commercial property. If you ask any municipality regarding trash pick up, you’ll get the same answer. Ditto with insurance companies.

Apartment buildings with more than four units ARE commercial properties. The only difference is that human residents occupy apartments, while businesses occupy the other spaces that most people think of when they think “commercial.”

But that’s a big difference!

So what should you do? If you’re going to buy a multi-unit commercial property, should you be looking for business tenants? Or should you stick with human tenants?

Before making your decision, consider this: Three out of four businesses go out of business after the first year. And 90 percent are out of business by year five. So if you’re renting to businesses, chances are your turnover rate is going to be higher than it would be with a residential property. This is problematic, because tenant turnover is the biggest expense you’ll face with any multi-unit property.

People always need a roof over their heads. If they move out of your place, they are moving into someone else’s. But businesses can just disappear … leaving you with a vacant unit and unpaid bills. (It’s hard to get money out of a bankrupt company.)

A lot of commercial property owners make the mistake of relying on three or four big tenants. If they lose one, they’ve lost 25 percent of their income. Think of what that would mean if we’re talking about a property that cost you $1,000,000.

Richard Anderson, on the other hand, bought a 110-unit complex in Atlanta, Georgia. Each month, he receives a positive cash flow of $6,422. If he loses 10 tenants, his cash flow will drop to $4,000 per month. If he loses another 10, his cash flow falls to $1,800 per month. But even after losing 20 tenants, he can still pay all of his expenses and has money left over to re-invest.

Statistics show that it takes an average of six months to fill a commercial space. The main reason is that the pool of potential renters is not very big. In contrast, with a residential property, there is a vast pool of potential renters … and the turnaround is one or two months instead of six.

For that same million dollars, you could get a 20- to 60-unit property (depending on where you invest). And if you have 20 units and lose one tenant, you’ve only lost 1/20th of your rent. You’ll still have plenty of cash flow and, more importantly, plenty of spendable income.

There is one other thing to consider: When you’re attracting a commercial tenant for your property, you usually agree to do a “build-out.” In other words, you agree to change the space to make it conform to the specific needs of that particular business. This could cost you thousands of dollars.

With an apartment unit, the “make ready” usually consists of new paint and carpet. If more is needed, it’s usually paid for out of the previous tenant’s security deposit.

Marion Pita, for instance, owns a 16-unit building in Birmingham, Alabama. She recently had two tenants move out and instructed her maintenance men to get the units ready for new tenants. They painted the walls…cleaned the rugs and appliances…and they were done. Total cost: $340. That costs a lot less than building walls and putting in doorways. Plus, it takes much less time, so you can start getting your cash flow faster.

Yes, apartments that are over four units are considered commercial properties. But, as you can see, they are in a class by themselves when you compare risk versus reward.

“I think the only thing I would’ve ever been any good at was probably being a pub landlord. I’ve thought of that a couple of times.”

– Joe Cocker

(Ed. Note: David Lindahl, also known as the “Apartment King,” has been successfully investing in single-family homes and apartments for the last nine years.)