A case for splitting residential and commercial management on a mixed-use property, even at extra cost

Say an investor buys nine apartments over two ground floor bays, 3,100 square feet of commercial space, one bay leased to a physical therapy practice and one to a bakery, for $1.41M with 25 percent down on a five year fixed loan with a 25 year amortization. A pattern worth studying: hiring two management companies instead of one. Residential goes to a firm that specializes in small apartment buildings at 7 percent of collected rent plus half a month for turns. Commercial goes to a brokerage's management side at 4 percent of collected rent plus a leasing commission structure, commonly 6 percent of the first five years of a new lease and 3 percent on renewals. A single manager charging 8 percent across the board, when asked directly, may never have done a commercial reconciliation and may not know what an estoppel is, while a residential-focused firm can be excellent at residential and honest that commercial is outside its expertise. The split typically costs more, perhaps $1,300 a year more than a single 8 percent quote, and adds two portals and a monthly reconciliation the owner does personally, but it buys competence in both disciplines. In a case like this, gross scheduled rent might run $172,000, actual collections $164,800, operating expenses including both management contracts $71,400, NOI about $93,400, debt service $78,900, leaving roughly $14,500 of cash flow and a thin 1.18 coverage ratio. The real risk sits in vacancy timing on the commercial bay. If the bay is vacant at purchase and underwritten to lease in 8 months, but the tenant's build-out runs long because of a permit fight over a hood and grease interceptor, free rent tied to certificate of occupancy rather than a fixed date can turn 8 months of lost income into 14, easily $19,000 more than planned and enough to draw a reserve down from $25k to $6k. The lesson is to size a vacancy reserve to 12 months rather than the underwritten lease-up period, and to negotiate free rent periods that end on a fixed date rather than on construction completion.

5 replies

karen_whitfieldPassivePRO

The free rent tied to certificate of occupancy is the whole lesson and you already named it. The tenant had no reason to push the city and every reason not to. A fixed outside date puts the permit risk on the party who actually controls the contractor. Did the lease have any construction milestone at all, or was it purely CO?

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karen_whitfieldPassivePRO

marcus_hale41CapitalPRO

1.18 coverage with $6k of reserve on a building with two commercial tenants makes me nervous on your behalf. Move one variable: the physical therapy practice doesn't renew. What's that bay worth annually and what does your coverage look like in the six months it's dark? Because from the outside it looks like you'd be at or under 1.0 and rebuilding a reserve at the same time.

I'd also want to know what the loan documents say about a coverage covenant. Five year fixed on a $1.06M balance, plenty of those have a tested DSCR and a cure period, and $14,500 of annual cash flow is not much of a buffer if a test date lands during a vacancy.

marcus_hale41CapitalPRO

tashaford30 SG2CPRO 16

The two-manager idea is the most useful thing in this thread. The question worth asking any single manager pitching one flat rate across the board is exactly the one raised here, whether they've done a reconciliation. Cheap question, and it tells you a lot.

tashaford30 SG2CPRO 16

brandonlee36 SP1BPRO 15

On the bakery bay, worth checking whether the leasing commission was paid at lease signing or at rent commencement. A commission paid in month 5 on a lease that didn't produce a dollar until month 14 is another few thousand added to the hole being described, and it's worth naming for anyone copying this structure. Commissions payable at signing are standard and negotiable.

brandonlee36 SP1BPRO 15

megan_doyle15PassivePRO

I don't understand half of this yet but the part about hiring the manager who admitted commercial was outside what they do stuck with me. Good sign about a person.

megan_doyle15PassivePRO

A case for splitting residential and commercial management on a mixed-use property, even at extra cost

5 replies