Difference between Commercial Multifamily and Residential Multifamily
The world multifamily itself is a bit vague. It could mean Commercial Multifamily or Residential Multifamily. Any multifamily with 2 to 4 units is called Residential Multifamily and anything 5 units and more is called Commercial Multifamily. It’s important to always clarify what a person is talking about when they mention the word ‘Multifamily’. Commercial Multifamily is totally a different beast. Simply put the biggest difference is that 2 to 4 units are treated the same as Single Family houses. In this article I have tried to explain the differences.
One of the biggest differences between commercial multifamily and residential multifamily is the kind of loans you can get. Commercial multifamily loans are generally given to LLCs (or other entities) owning the property. Whereas usually residential multifamily loans are given to individuals owning the property. In many cases – the Commercial Multifamily loans can be non-recourse. Meaning besides the property mortgaged, the bank may not come and try to get the owner’s personal assets in case of a default. In most cases residential multifamily loans are recourse loans, the owner bears full responsibility and if they default, the bank will try to get the owner’s personal assets. Residential multifamily loans generally have 15 or 30 year terms. Whereas Commercial Multifamily loans have 3, 5, 7 or 10 year terms. A 10 year term means the loan is due in 10 years. Please keep in mind that ‘term’ is different from the amortization period. A 10 year term loan can have amortization of 30 years. It’s also very common to have interest only periods for Commercial Multifamily loans. Agencies (Freddie Mac and Fannie Mae) are the predominant players in Commercial Multifamily loan space. In Residential space, Freddie Mac and Fannie Mae do not directly lend, they usually guarantee the residential loans.
This is a very important distinction between Commercial and Residential Multifamily. Residential Multifamily is valued by looking at the comparables. The appraisers look at the similar properties in the neighborhood and based on it, decide the value of the property. The most common way of appraising Commercial Multifamily is to use the following formula:
Net Operating Income is the income of the property without considering any debt service (or mortgage payments). Cap rate is the market factor here. Usually brokers in the area can tell you about a prevailing market cap rate for a given property.
This formula is a very powerful tool for multifamily operators. This formula essentially states that if you increase the net operating income of the property, the property valuation will go up, given the market remains the constant. Because of this method of valuation, many multifamily operators make improvements to the property so that they can increase the rents and thereby increase the net operating income.
Buying & Selling Process
In Residential Multifamily space, the buyer is helped by a Realtor or a Real Estate Agent. The agent negotiates on behalf of the buyer and also helps the buyer do the paperwork necessary. In Commercial Multifamily space, the buyer is assisted by their lawyer. The seller is assisted by the Broker who lists the property. In addition to the Broker, the seller also has a lawyer assisting them.
Residential Multifamily properties are listed on the MLS just like a single family house. Generally, Commercial Multifamily properties are listed on Loopnet.com (or few other websites), But there is no one big platform like MLS where all Commercial Multifamily properties are listed. It is common to not list the property on any of these platforms. And that is why in Commercial Multifamily space buyers try to build relationships with as many brokers as possible. Residential buyers do not need to have any relationships with the seller’s real estate agent as they can find pretty much any property on MLS easily.
It’s very common to have a 30 day escrow period for Residential Multifamily. The common escrow period for Commercial Multifamily is 45 days to 60 days and it’s also very common to take months to complete the transaction.
It’s very rare to see Syndications in residential multifamily space although there is no regulation that prevents it. Syndications are very common in Commercial multifamily space – especially when you go 30 units and above. One reason for it is that it’s very expensive to buy a 30 unit or more building by one person. Also, getting a mortgage for an LLC is very prevalent in Commercial Multifamily and that makes it easy for a syndication to operate.
There are really many other areas where Commercial Multifamily differs from Residential Multifamily. It could be the subject of a book! But the above mentioned differences are the most important ones in my opinion.