What makes Commercial Real Estate Different from Residential Real Estate?

(Editor’s Note: I recently came across an interesting blog put together by Stephen Cugier and Nick Papa from Grubb & Ellis that focuses on Seattle’s commercial real estate market. In talking with them, I thought it would be interesting to have them post an occasional article on aspects of commercial real estate that might be of interest to people who generally follow the residential side of things. This first post by Nick will likely be particularly interesting for investors thinking of expanding into commercial real estate. )

The fundamental difference between commercial and residential real estate is the fact that all commercial properties are potentially income producing while most homes are occupied by their owners. While you can obviously purchase a home and rent it out, it is not considered commercial real estate. The four main product types that comprise commercial real estate are office, industrial, multi family (apartment) and retail properties. There are other commercial property types such as hotel/motel or mobile home parks, but these are the primary products and those that an individual investor might consider investing in.

Each product type has its pluses and minuses depending on a variety of factors including, but not limited to the management of the property, the size of the investment and amount of inventory available. Naturally the value of any particular property is also subject to typical market conditions such as location, physical attributes and current demand for that type of product.

For most investors entering the marketplace who have owned residential properties that they have rented out, multi-family is where they feel most comfortable. The benefit to these investors is that multi-family properties tend to be the most attainable commercial properties because you can start with something simple like a duplex and go up from there. One note here; apartment property five units and larger comes with much stricter financing requiring a higher LTV (loan-to-value) ratio while duplexes to fourplexes can be purchased within single-family financing parameters. Apartment properties also allow owners to save money on property management fees by maintaining and managing the properties themselves, typically for buildings less than 10 units.

Office, industrial and retail properties typically require a greater amount of initial investment because it is more difficult to find smaller properties (i.e. less than $1M) to purchase. These types of properties also require, in most cases, some form of professional management. This is because negotiating commercial leases with businesses is much more complicated and difficult than negotiating leases with individuals in rental property. This element can also be a benefit as it allows the investor to simply purchase and monitor their property without having to deal with the day-to-day hassles of management. These types of investments can be very attractive when there is a solid long-term tenant in place or where there is potential to substantially increase rents on the property.

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One other factor that needs to be mentioned in this discussion is IRS Code 1031. This part of the tax code allows owners of commercial property to defer the payment of capital gains taxes when they sell an investment property as long as they purchase a property of greater value within 180 days. This is very common in commercial real estate and is a great way for an investor to increase their real estate holdings and as a vehicle to gain tax free cash while leveraging their real estate assets.

If you do consider commercial real estate as an owner or user, it is best to work with trained commercial specialists. They can help guide you through the complicated process of identifying and purchasing (or leasing); which often entails working through proposals, offers and considerable analysis. Commercial specialists often know of unlisted properties that may be available through their network of landlord and owner contacts. They are also a great resource in assessing the financial viability of properties, which ultimately will determine their worth as an investment.

Comments

  1. Excellent post! Before I comment, are you Stephen or Nick?

  2. I just added a little text in the intro to clarify that the article is by Nick!

  3. I was more concerned with whose photo it was, than who wrote the article :-)

    I agree with everything you say, Nick, and until recently was able to stay on the residential side of things. But I am increasingly called on to get involved with the sale or purchase of condos for investment purposes (single units), duplexes, triplexes and fourplexes.

    I am told by the consumers who approach me for assistance with investment property, including 1031 exchanges, that the commercial brokers are not interested in helping them with these lower priced properties.

    Those I have assisted to date tend to be first time investment purchasers who need more “hand holding” than commercial brokers seem to be willing to provide.

  4. Bob Cryan says:

    Ardell, I appreciate your posting and your position. I believe there are those in the Commercial Business who don’t have time for the first time investor. I, however have had tremendous success with initial investors. My 25 years in the business helps me guide first time investors with a good business plan to build wealth through real estate investing. I have many first time investors who have gained significant wealth from implementing investing strategies I have helped develop. So, perhaps I am the exception to your rule but I am sure I am not alone. Because first time investors will be loyal to those brokers who help them build wealth.

  5. Well Bob, if I could figure out who you are and if you are local, we might be able to work something out :-) I prefer my clients to have the best, and make every effort to give them that, even if the answer is a referral to someone else or a collaboration of two agents.

    Any commercial agents in the Seattle area willing to help a first time investment buyer (who owns their own home, so not a “first time buyer”) who wants to buy a condo on the Eastside for under $150,000 to rent out, contact me off site…or on…your choice.

  6. Keep me in the contact loop as well! Anna had a lead this week from someone looking to lease and/or buy commercial real estate, and while we did pass the lead to someone who I think will treat the client very well, I’d be interested in hearing from additional people who serve this market!

  7. Does anyone know what it takes to turn residential property into commercial/retail property etc.?

  8. Eliza,

    It looks like your comment slipped through… My guess is that no one answered because that is a huge and complicated topic and really depends on too many factors to easily list. Do you have a specific parcel in mind? If so, let us know some more details about the parcel, and people will likely be able to give you some feedback!

  9. Kevin O'Connor says:

    Apartments Wanted

    We are looking to buy a few apartment buildings, they must have 60%+ two bedrooms, 70%+ hook ups in,and built 1980-2006, mapped if possible. Very serious buyers…

    Give me a call or e-mail anytime.

    Kevin O’Connor
    Western Consulting
    3905 State Street suit7-196
    Santa Barbara Ca, 93105
    805-895-9419— wcrc@cox.net

  10. The difference between commercial and residential real estate is well known by every real estate agent, but believe it or not most people dont know the difference. Great Post!

    Walt

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