In the realm of multifamily investing, there are many different subclasses of multifamily. Subclasses such as affordable housing, market-rate, luxury, student housing, senior housing, mixed-use, etc. The best operators choose one or a select few to focus on to become their niche as each subclass has its own benefits and challenges to navigate. At Volcan Captial, our two subclasses of choice are market-rate housing and mixed-use. These are categories we are knowledgeable, experienced, and passionate about.
Market-rate multifamily is comprised of standard apartment communities. These are apartments that have market-priced rents with good-quality residents in good-quality buildings. This is not the top-tier apartments or the low-quality apartments, it's right in the middle.
Mixed-use is a mix between apartments and commercial rental space. The commercial rental space can be either retail (store/restaurant), office space or a combination of these. Mixed-use is most commonly a commercial space on the first floor with apartments above, however, they can be any orientation. Here's why we like mixed use:
Reason #1 - Stability
We have found mixed-use to be very stable, specifically due to the low turnover of the commercial space. Once a quality tenant is leasing the commercial space, they tend to stay for much longer periods than an apartment resident. The tenant renting the commercial space is a business, and once established, they don't want to move.
The commercial tenants also have a tenancy to be reliable with payments. Given the business was properly vetted, there is less emotion and personal ties to rent, it's simply a business expense.
Reason #2 - Diversification
Mixed-use provides diversification through changing market conditions. Although Covid has made commercial space less desirable due to the option to work from home, we're seeing a strong demand return. Mixed-use provides a cushion on each end. The apartments are very strong during tough economic times and mixed-use is even stronger during good economic times.
Reason #3 - Strong income and lease terms
Another reason we like mixed-use is due to the high rent and strong lease terms for commercial space. Commercial rental space is treated a bit differently than residential. Commercial rent often includes payment for taxes, insurance, utilities, and even maintenance. Commercial rents are also leased much higher than residential space. Commercial spaces can often be leased for double or triple the price of a residential apartment. There are many different lease structures to choose from with commercial space.
Reason #4 - Community sentiment
Lastly, one of our favorite aspects of mixed-use is the sentiment of the property. We have found that our residents enjoy the community provided by having a business as a part of the building, specifically when the business is a coffee shop, restaurant, or popular store. When there is a retail store attached, it's a great idea to work out a discount for residents who shop there. For example, residents get 10% off every cup of coffee or meal. This creates a very strong community between the residents and businesses and even helps support each other.
With the benefits of mixed-use, there are two challenges that are prominent:
Challenge #1 - Lending
Mixed-use is viewed as more difficult to operate and therefore a bit riskier. With that, it is more difficult to get financing, or the terms are not as favorable as a building with residential apartments only.
Challenge #2 - Leasing
Finding, vetting, and leasing a commercial space is substantially more difficult than a residential space. Commercial spaces are often vacant for much longer periods of time and there are aspects of commercial leasing such as buildouts that make this more complex.
All in all, we have found mixed-use to be well worth the added challenges that come with it. Mixed-use buildings help create a community as well as offer strong leasing terms and stability.
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