5 Ways Commercial Real Estate is Different Than Residential
Commercial and residential real estate differ in many ways, which is why it can sometimes be difficult for a residential investor to transition into the commercial arena without professional assistance. These are just some of the ways residential and commercial properties differ:
1. Property Occupancy. Residential real estate is a single-family home or building with 4 residential units or less (i.e. duplex, triplex, 4-plex) that has individual(s) or family(ies) as tenants. A commercial property is any property that has commercial businesses as tenants or a multifamily complex with 5 or more units. Both a residential and a commercial property will be zoned accordingly with the county it is situated in.
2. Property Valuation. Single family residences are typically valued based upon comparable properties on a per square foot basis (i.e. $100/sq.ft.). Although commercial properties can be valued in this manner as well, capitalization rates are generally equally if not more important in determining a property’s value.
3. Financing. Commercial real estate loans are underwritten and structured very differently than residential real estate loans. While residential loans are dependent on the borrower’s personal income and financial strength, commercial properties are underwritten by taking other things into consideration including borrower experience, property cash flow, occupancy, location, property type, and tenants. Residential mortgages can go up to a 97% LTV (through FHA) and are typically structured by using 15-30 year self-amortizing loans. Commercial loans (with few exceptions) usually only go up to an 80% LTV for investment properties and 90% LTV for owner-occupied properties and are usually fixed for a term that is shorter than the amortization period (i.e. 10 year term, 30 year amortization).
4. Legalities. The laws surrounding home ownership and residential leasing (i.e. landlord-tenant laws) are completely different than the laws surrounding commercial real estate. In almost all states, landlord-tenant law heavily favors the tenant in matters involving disclosure, eviction, and repairs/maintenance; residential landlords typically have a higher threshold of responsibility than commercial landlords.
5. Required Experience. Although it’s fairly easy to purchase your own home or a rental property with little to no experience, it is much more difficult to own and run a commercial property with no experience. Commercial properties require at least a basic knowledge of area rents, tenant negotiations, expense management, property maintenance, and financial analysis to make sure required returns are being met.
Author: Leanne Eicoff