May 6, 2021

What's the Difference Between Residential and Commercial Multifamily?

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By

Dave Seymour

What's the Difference Between Residential and Commercial Multifamily?

When it comes to investing in multifamily properties, there are two main categories: commercial and residential. Commercial multifamily is any property with more than 5 units. Residential multifamily has less than 5 units. Each type of rental property has its own advantages and disadvantages, so let's take a look at some of the things you should know about each one!

Types of Multi-Family Units:

Broadly speaking, multi-family units can be grouped into two categories: those that house between two to four units and those that house five or upwards.

Factors such as location, socio-economics, and many others come into play when deducing just how beneficial the investment is. However, depending on your investment strategy, the foremost consideration should be the size of the unit.

  • Multi-family properties with two to four units are considered residential properties and therefore acquisition is easier. However, it limits the streams of income coming in.
  • Multi-family properties with five or upwards units are considered commercial properties and are therefore more difficult to acquire. However, the streams of income coming in are higher.

The drawback to commercial multifamily is that there are higher investment and management costs which can make it difficult for a single investor to take full advantage of this asset class.

And while residential multifamily is easier to acquire, there are fewer economies of scale, and building a large portfolio will take a lot more transactions.

- Residential multifamily is easier to acquire, but there are fewer economies of scale and building a large portfolio will take more transactions.

- Commercial properties have higher investment costs and management fees making it difficult for one investor to fully capitalize on this asset class.

*For our purposes, we define "commercial" as having five or more units


Managing a Commercial Multi-Family Building vs. a Residential Building:

Think of it this way: if your tenants in a residential building have maintenance issues and they call you up or the manager you assigned to fix them, the amount you'd be spending would come from the rent you're collecting.

Or consider vacancies. If one tenant is vacant in a duplex, that is a 50% vacancy and a major hit to the overall return. If one tenant is vacant out of 10, that is only a 10% vacancy. In our business, 10% is still a large vacancy, but as we acquire larger buildings, there are more tenants to make up for any loss of rent from a few vacant units.
  • Properties with two to four units are smaller and therefore easier to maintain. Maintenance costs are lower. However, the costs might make up a significant portion of the money the property usually generates.
  • Properties with five or more units might be larger and much more time-consuming to maintain and manage. However, the stream of income easily compensates for costs.

Each property has its advantages and disadvantages. It’s important to know what you want for your portfolio before making any decisions.

Acquiring a Multi-Family Property:

Investors usually have a passive role in the entire investment process. They might invest in a real estate fund or hire a manager for an individual deal and are rarely the ones scouting locations themselves.

Acquiring properties to invest in can take a few months or a few years. It depends on how long an investor is willing to wait to put down their money on a property. A key difference between smaller and larger multi-family units is acquisition.

Smaller units are listed as residential units and therefore follow pre-determined guidelines. These guidelines include tenant-landlord agreements, rent inflation, maintenance, etc. Residential units are generally easier to acquire because the process is fairly direct and evolved for ease.

Larger units are trickier. A property with five or more units is considered as a commercial property. Commercial property acquisition isn’t as easy - the process is time-consuming and requires a whole lot of paperwork to be done before a sale can be made, or before tenants can move in.

However, the flip side to waiting this long is the increased ROI and rent adjustment at the investor's discretion.

It is important to note the distinction between residential and commercial multifamily properties when making a purchase. There are several distinctions and we want to explain one of them: under five units versus over five units. Residential property acquisition is easier, while commercial property acquisition can be more time-consuming with increased ROI at the end.

Conclusion:

An investor is only as good as his or her portfolio. Which means they're constantly on the lookout for better investment opportunities. Multi-family units are a great way to boost your portfolio and increase ROI.

Notwithstanding the obvious difference between a single-family and a multi-family unit, there are even more differences between smaller and larger multifamily properties.

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