Ash Patel and Joe Cornwell engage in a head-to-head debate, diving deep into the nuances of commercial versus residential real estate investing. Drawing on their years of expertise, these industry titans provide insights, challenge perspectives, and share personal experiences that are bound to resonate with every real estate investor.
Key Takeaways:
- Vacancy & Value Growth:
- Joe argues that residential real estate, especially 1-4 units, is influenced heavily by comps, which can sometimes be beneficial, seeing property values doubling unexpectedly.
- Ash emphasizes the potential of commercial real estate, highlighting that value isn't strictly bound by comps. The signing of a long-term lease with a big name can drastically increase a property's value.
- Tenant Management:
- Commercial tenants, often business owners, tend to be more self-reliant, potentially even investing in the property's upkeep themselves. This can reduce management headaches, evictions, and provide more predictable revenue streams.
- Joe counters by noting that proper screening and management can similarly reduce residential real estate risks.
- Recession Resilience & Mixed Use Properties:
- Both Ash and Joe agree on the recession-resistant nature of certain types of properties, specifically mixed-use properties. Combining both commercial and residential tenants can offer a safety net for investors, ensuring steady revenue even in challenging economic climates.
Joe Cornwell | Real Estate Background
- Founder of Realty One Stop
- Portfolio:
- 125 units
- Based in Cincinnati, OH
- Listen to his previous episodes:
- Based in: Cincinnati, OH
- Say hi to him at:
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Transcript
Ash Patel:
Best ever listeners, welcome to the best real estate investing advice ever show. I'm your host, Ash Patel. Today's episode is brought to you by Presario Ventures, a private equity real estate firm based in the booming Austin, Texas market. To learn how you can invest in the future of Texas with Presario Ventures, please visit info.presarioventures.com forward slash best ever, or click on the link in the show notes. I'm with today's guest, Joe Cornwell. Joe is joining us from Cincinnati, Ohio. On the last episode we mentioned he is going to be a new host alongside of Slocomb, Travis, Joe Fairless, and myself. And on his intro episode, we created a challenge for each other. We wanted to talk about commercial versus residential. I am a non-residential commercial investor and Joe is primarily a residential investor. So Joe, I'm going to let you take it from here. How do you want to do this? How do you want to learn that commercial real estate is better than residential?
Joe Cornwell:
Well, let me start by saying that Ash and I have had this conversation off air before many times, sometimes after a couple of drinks. So sometimes we've had a little passionate exchange. So I figured, you know what? I thought this would be a cool topic to bring to the viewers. Let them get a little insight into some of the things that we talk about without the alcohol and without the profanity, let's say. But I want to give a view of my perspective on residential commercial real estate, and we'll include even typical residential, right? One to four units. I still have a love for that asset as well. So I will start by saying a disclaimer of, I don't have any issue with your philosophy in general, but I do think there's reasons why my philosophy is better. Let's put it that way. And my first point to make is the reason I prefer residential over non-residential commercial real estate is the vacancy.
To me, that is probably the most defining factor. And I'll admit, it's one of my biggest fears to getting into commercial real estate. And if you'll indulge me, I'll give you a quick backstory. So when I was a brand new cop coming out of the last real estate recession, every town I worked for, and these are good CB type of neighborhoods, I was lucky to work in some good suburbs, had so much commercial vacancy coming out of that last recession that it scared me from even pursuing that asset class. And in contrast, when I got into doing residential and small multifamily, and now obviously growing into larger multifamily properties, vacancy to me, and this is market dependent, but in my market at least seems to be a much more controllable factor in the residential side than what I've seen in the commercial side. So that'd be my first point to you.
Ash Patel:
Man, I wish we were drinking. That'd be a little bit more interesting, but okay. Challenge accepted.
Vacancy is a fear of yours. It's another reason you should gravitate towards commercial real estate. And by the way, you can have not just one to four units, but all multi will group all of that into residential. And I know commercial loans are five minutes or more. My definition of commercial is anything non-residential commercial, including mixed use. All right. So. Vacancy, if that's your fear, you should embrace commercial real estate because there's tenants who will sign longer term leases with corporate backed guarantees or personal guarantees. If you have a 10 year remaining term on a lease from a national tenant, unless they go bankrupt, look, Starbucks is not going bankrupt, right? A lot of these retailers are very healthy. Their balance sheets are incredible. It's not like the big box stores, JCPenney, Toys R Us. I'm talking about small three, four thousand square foot spaces they will have multi-year corporate guaranteed lease and that should withstand whatever market cycle you endure. So I'm sure we both agree we're heading into a recession. We're already knee deep in the recession and we could have a year and a half left. We can have three, four years left in that recovery period. Nobody knows, but having that long-term national corporate backed lease gives you that comfort that your rent is going to be paid no matter what, regardless of what the economy is doing. Now there's other tenant classifications where there's mom and pop tenants and yes, they can succumb to economic headwinds and they can fail and you often have little recourse, right? But my point is you have as much safety or as little safety but higher returns as you want in commercial real estate. So I believe...we check the box under commercial for that.
Joe Cornwell:
All right, well, let me counter your point there. So I agree with you in the big box or mid box, let's call it corporate backed commercial leases. That is a massive advantage in commercial real estate. And what I'm specifically referring to is that when you have these small one-off strip centers, single building centers, mixed use, like you mentioned, those are where I'm seeing, and I've historically, let's call it over the last 10 years of my adult life that I've paid attention to it. That's where I've seen the highest vacancies. And I'm speaking strictly from personal experience, where you'll have a town that has good traffic, it has great residential property, it has high demand, all those things that you would typically, or at least I would think you would wanna look for in a commercial real estate, but for whatever reason, these small properties, and even mid-sized properties can struggle to keep tenants, to place tenants. I've seen properties that were vacant for years even. And I've even actually bought some of those that I'm talking about and converted them to residential because they could just not keep a tenant in place. So I will concede the point to the large, big corporate brands that you're mentioning. But honestly, and I guess this is a question for you.
What percentage of your portfolio would you say falls into that category of this mid to larger corporate backed guarantees?
Ash Patel:
I would say less than 15% because those are often the type of assets that people go to place money in. They park money in 1031 money. The returns are not higher in those assets. Now, my ideal retail property would be a strip mall that has some national tenants, some local regional tenants, mom and pops, and some vacancy. We're value add investors, but let me end this by saying your point is valid, but I will tell you that suburban strip malls are absolutely on fire. Suburban office buildings that are in downtown walkable suburbs, not surrounded by giant high rise office buildings, not the class A office park. But suburbs have blown up post COVID. The millennials who were eventually going to move out to the suburbs, COVID accelerated that because they got tired of living in these little boxes where bars and restaurants weren't open. They're on lockdowns and they wanted a yard, a place for kids and pets. Eventually, just like we, when we were young, we wanted to live in urban metropolitan downtowns. And as we got older, we moved out to the burbs. COVID accelerated that. So the demand in the burbs.
That's where all the newest hottest restaurants and bars are popping up. So suburban retail where the dog groomer is the dentist, the optometrist, the pizza place, the deli, those are internet resistant and recession resistant. Now allow me to bring up another point because vacancy, I think we beat that. The best ever listeners can keep track at home, get us on LinkedIn and give us your tally at the end of this. Joe, my biggest metric is returns. With commercial real estate, we're not bound by comps. You can literally have a vacant $300,000 block building with a metal roof. If you sign a 10-year lease with a dollar general, you just created a million dollars plus in value. With apartments and houses, you're bound by comps. I had a buddy of mine who had a $300,000 house he was putting $150,000 into a bathroom and kitchen renovation. I wanted to be respectful, but also give him my opinion on it. And I asked him, I said, how much do you think you are increasing the value of this house? And he said, look, I know I'm not going to get this money back. My house will always be worth plus or minus $10,000 from the last home that sold in this neighborhood. So comps are very constrictive.
to growing value in residential real estate, not the case in commercial real estate. You can have a mom and pop coffee shop worth $100,000. You can have a Starbucks worth $2 million right next to each other, same size building, everything. So the value add and the ability to massively grow returns, I believe, is a no brainer in commercial real estate.
Joe Cornwell:
All right, so my counter to that point would be if you are specifically cherry picking the one to four unit properties, I would agree. Obviously we all know they're based on comps. So I'll make a point about that in a second, but if we look at just commercial multifamily real estate, I would argue you have every opportunity that you have in commercial real estate because we've seen the way rents have grown over the last 10 years, the same way that many rents have grown in commercial real estate, non-residential. And they also work off of an income, they also work off of a cap rate. And...
that is going to give you the same or similar benefits that you would get in commercial estate. But back to the one to four unit, I will give you a point and again, personal experience, this is gonna be very market and micro economic factor specific, but I actually have a residential property, it's a duplex in a really prime suburb of Cincinnati, where if you were to value it based on income, it would be worth half of what it's worth simply because of the comps. The comps are so outrageous in this particular neighborhood that the ARV, after I renovated this property, was double what I projected because of the growth of that particular market. Now, again, I know that's specific. I know that's very micro and that's not a common occurrence, but as much as it could be a downside factor, it could be a positive factor in the right market if you buy right. But back to the greater point, I don't think that that's a specific benefit when you're valuing real estate based on income. And again, if you factor in that vacancy, I would argue that not only could you raise the income in a similar way on residential, you're also going to have less risk and lower vacancy while you're doing it, which would then add to a more guaranteed income and value with multi-family. So that would be my counter to your argument.
Ash Patel:
Do you agree that there's a cap on what you can charge for rent, whether it's an apartment, single family based on comps. If you're a class B building and the brand new class A building down the street is charging a thousand dollars a month, the most you could charge is 900. Right.
Joe Cornwell:
I would agree that it's going to be capped based on the comps in your market, but I would also say that commercial real estate faces that exact same factors. If you're in a small suburb and there's three small, like you said earlier, that suburb strip center, you're going to be within that range of the market, right? You're not going to be able to go in and double the square footage rent that the guy down the street's getting or guy down the street's getting, right? So yes, I would agree that it's capped based on comps, but I don't think commercial real estate is excluded from that.
Ash Patel:
Okay. So let me give you another example. There was a buddy of mine who had a mom and pop restaurant and Darden restaurant group, they're on the New York stock exchange. They ended up signing a lease for one of their brands. Forgot which one it was, regardless. The cap rate on that property went from about a nine cap, because it's a mom and pop tenant down to a six, six and a half cap because it's a national corporate backed lease. So that I don't think you can do in residential real estate is drop the cap rate by 200, 300 basis points.
Joe Cornwell:
Yes, I would agree with that. I would agree that control over cap rate compression is more benefited in commercial estate.
Ash Patel:
Okay. And then I'll agree with you that it's similar. No, why income approach all that. All right. So let me make this one. My second point. Okay. That was two. This is your second point. Right.
Joe Cornwell:
So I find that residential real estate. And at least in my business model, I know not a lot of other operators do the same thing is very systemic and scalable. And what I mean by that is I take my model with my contractors and we do the same renovations and the same color scheme and the same flooring. And we replicate that all over the city and all of our properties. And once your crew understands what you're going for, it's very easy to plug and play employees and contractors and subcontractors. And I would argue that in commercial real estate, those properties most often are very unique. So you're gonna have a unique build out based on your unique tenant. And it's much less scalable in that regard, and it's much less systematizable in that regard. Because you're going to do different things in every market, every property, every neighborhood, every tenant is gonna want a little bit different. So that would be another point I would argue is, easier and better in residential real estate.
Ash Patel:
You're right. We can't systemize what we do in commercial unless you're talking about flex space, but let's avoid that for now. It's hard to systemize it, but what I'll tell you is that often our tenants will do the renovations. Sometimes they do it on their dime. If it's a national tenant, they want tenant improvement dollars, or they want us to do it to their specs. But in residential real estate, imagine if your tenants called you and said, Hey Joe, I just remodeled the bathroom, put a new roof on. Are you okay with that? That doesn't happen in commercial that happens. So I think these are two different areas. But what I will tell you is that our tenants are much easier to manage. Our tenants are business owners. Their income comes from the space that they're leasing.
During COVID, there's a lot of stories of business owners who would not pay their home mortgage or apartment rent because they knew that they had some leeway there, but they wouldn't dare not pay their commercial rent because that's where their income comes from. That's where their revenue, where they get money to live comes from. So the caliber of tenants are often much better in commercial real estate, easier to deal with. We don't get calls on leaking toilets and sinks and showers and stoves not working. These are business owners who often will improve their own space, make whatever repairs, and often the leases will dictate who's responsible for what. So I guess this is my second point, and that is the quality of tenants and easier to manage commercial real estate.
Joe Cornwell:
I completely agree with you. There's nothing I can say that will argue that point because you're right.
But what I will say, and this is, I guess, a side note, there are ways to commercialize your residential property. And this is something, a strategy that I stole from Ash. I stole some of the things he taught me in his commercial real estate from our conversations. And that same property I was just talking about where the value came in almost double what I projected, I was able to go out and find a commercial tenant for a residential property.
And I have a lease with a scrapping company out of Chicago that has contract work here in Cincinnati. And they pay me by the room. They place their own tenants. They pay for all the maintenance. They pay for capex up to $10,000 one-time cost. They also signed a three-year lease with built-in 5% annual increases, another thing you taught me to do. And it's kind of the best of both worlds, right? Because it's like a double net lease on a residential, this is just a duplex, right? Regular residential property. But it takes all the risk out of it because I'm not dealing with tenants, I'm not the one taking the phone calls, I'm not the one taking care of maintenance, and I'm getting above market rent because I got a corporate backed guarantee and they want a landlord who's easy to deal with and they're gonna be easy to deal with because they wanna make it work. So.
The only point I'll make is that if you are a residential investor, don't be afraid to go out and market to businesses that are looking for housing.
Ash Patel:
I love it. That's a great point. Let me share that I think we've had one eviction in 15 years of doing commercial real estate. We typically just don't have to evict tenants. If their business isn't working, they're leaving. It's not like they're going to stay and hang out for free.
They don't have products to sell. They don't have employees because their business is failing. They're done. They're going to close up shop. They're not going to destroy the facility on the way out. So dealing with tenant evictions, we don't have tenant friendly laws in commercial real estate. If you have to argue a case in front of a judge for commercial real estate, the judge assumes both sides are big boys and girls. They both signed a contract.
And they knew what they were doing. They're professionals. No one took advantage of anyone. Whereas there's a lot of tenant friendly laws where it's, okay, we want to keep these predatory landlords in check and protect these tenants and they apply those rules blanket wide to everybody. So that's a point in terms of legality and evictions.
Joe Cornwell:
Yeah. And my only response to that would be outside of one property I bought, and I knew this going in, I inherited 20-something tenants that were not verified. They did not have income verification. They didn't have background checks. I bought this property from a slumlord, and I knew going in it was gonna be a nightmare getting these people out because it wasn't gonna go well. So outside of that one property, I don't think I've actually had another eviction on any other property in my portfolio because if you screen your tenants well, if you income verify, you're going to minimize your risk. So I'll agree that you're in a better spot in commercial real estate with less likely evictions, but I think if you operate well, if you have a good manager, you can limit your risk in the residential space as well. And then to my third point. My third point is that I would argue that residential real estate, especially in that C and D class criteria of multifamily, is much more recession resistant than specific parts of commercial real estate. So I'm not going to say all areas of commercial real estate are at risk with recessions, but I would argue that many of them are.
Ash Patel:
I don't have a good argument for you. And I would say you're right. People will always need a place to live. Class A and B tenants can always resort to mobile homes or class C apartments. I agree with you there. Let's end this on.
Maybe something that we can agree on. What are your thoughts on mixed use properties?
Joe Cornwell:
Mixed use is probably the only asset class within commercial estate that I would be interested in. And it's because I like the residential aspect and the way I view those is if I can at least break even on my residential units being that being my area of expertise in my comfort zone, I look at the commercial space as cherry on top.
That's going to be my profit margin. So I would as an investor, definitely be open to those asset classes. I have a feeling you're probably going to say the same thing with the exact opposite approach, but yeah, I would be open to mixed use.
Ash Patel:
No, I agree with you a hundred percent. Matter of fact, I've done a beyond multifamily episode. If you Google Ash Patel, Joe Fairless, mixed use buildings, it should pop up. I think it was a 30 minute episode just on mixed use. So best ever listeners, I think it's a great segue to get into commercial, learn about commercial, having a backstop of apartments that will pay for all of your expenses. Mixed use buildings fall through the cracks and Joe, you know, we forgot to mention on the last intro call that you're also a licensed realtor. And Joe was responsible for selling a couple of my mixed use buildings. So the mixed use buildings, the apartments will typically pay all of your expenses and may even yield a little bit of profit.
The commercial is all gravy. So you have this safety net of having guaranteed income coming in and the commercial is all profit or vice versa. The commercial, if it's leased out, the apartments are vacant in need of renovation. The commercial will pay all of your expenses and the apartments are profit. But commercial people like me hate mixed use because I don't want to deal with the residential side of things. The residential people are afraid of mixed use because they don't understand the commercial you can often find great deals on these mixed use buildings. So I'm glad we can end this on something that we agree. What a fun conversation.
Joe Cornwell:
And the last thing I'll say is that commercial real estate, residential real estate, there are both plenty of ways in both asset classes to make money. I know a lot of successful investors in both niches. So I agree with you. I don't think if you're in commercial and you never got into residential, I don't think you should be afraid to take that leap.
If you're in residential, I don't think you should be afraid to look at commercial real estate as long as you buy right. And you have a good solid plan that makes sense. You can be successful in both niches, but I love to get on here and argue with you and try to prove my point. So I appreciate, I appreciate you having us as our second conversation together
Ash Patel:
I love it, Joe. Thank you for your time. Best ever listeners. Thank you for joining us. If you enjoyed this episode, leave us a five-star review, share this episode with someone you think can benefit from it.
Joe again, thank you for your time. We should probably do this again while we're drinking. Best ever listeners have a best ever day.
