10 Differences Between Commercial and Residential
Commercial Real Estate has many nuances that make it very different from residential. While residential brokers may think they have the knowledge and skills to enter the commercial real estate(CRE) game, there are many differences between the two markets. Without a solid understanding of property valuation, rent structure and the various segments of CRE, you may find yourself in over your head.
What is Commercial Real Estate (CRE)?
Commercial properties might refer to:
- Retail buildings
- Office buildings
- Industrial buildings
- Apartment buildings
- “Mixed use” buildings, where the property may have a combination of uses, such as retail, office and apartments.
1. Commercial Real Estate Is All About Your Network
The agents who work residential and commercial real estate work in very different ways. In commercial, it is very much about who you know, and the bigger network you have, the better. There are deals that are never listed because you know the right agents you can find the “off-market” deals.
2. You Need to Understand the Different Segments and Markets In Commercial Real Estate
For residential brokers who are looking to move into the CRE arena, you should move slowly and understand the marketplace and the players. Commercial real estate is divided into four major groups: industrial, office, retail, and hospitality. Within those segments, there are specialized investors who are buying and selling regularly. Many of these assets trade off-market.
3. Residential Properties Are Subject to the Whims of the Owner
Real estate is real estate. Size of transactions maybe one differentiator, but there are $300 million single-family homes and extremely cheap commercial assets, so even that’s a wash. The real difference is the use case. In residential properties, the whims of a single owner can impact sales, rents, and the pricing of an asset dramatically. Commercial use properties are, for the most part, just a utility – a part of commerce.
4. Commercial Real Estate Requires Diligent Documentation and Income Data
If you’re flipping a house, the buyer doesn’t care about the growth or reliability of your property’s income stream. For commercial real estate investments, you’ll need to show exceptional returns for potential buyers when you decide to sell. Diligent record-keeping of income, expenses and performance is crucial in a commercial investment. Users and renters (lessees) want to know what’s included in CAM charges, how much are utilities, etc.
5. Commercial Real Estate Yields Higher Income, But Residential Properties Are Easier to Finance
Commercial properties typically have longer lease agreements and higher rental income opportunities. If you are representing potential tenants, or owners, longer leases are better with fixed increases better for tenants and CPI raises better for owners. If you rep residential real estate, it tends to be less complicated. Financing for residential properties is much easier, while commercial properties tend to be more expensive and require more capital upfront. The longer the leases and the better the credit of the tenant, the easier the financing in CRE
6. It’s Easier to Get Rid of Non-Paying Commercial Tenants
The big difference with commercial versus residential is the ability to get rid of your non-paying tenants. With residential tenancy you deal with a lot of tenant rights. Unfortunately, some people abuse the system and end up squatting for lengthy amounts of time on the landlord’s dime. In commercial leasing, if they don’t pay they are out, especially if the “good guy” clause is in the lease. That means that if they are behind in rent a negotiated amount of time the promise to abandon the property without a fight making them good guys.
7. Commercial Real Estate Is a Team Sport
Residential: See five houses Saturday, make three offers, accepted contract Monday. Commercial: Trusted team of brokers, lenders and underwriters work together with buyers. Brokers co-broke much more often than residential brokers. Residential brokers fight for exclusives and so do commercial brokers. But the rush to list properties on MLS (CoStar or Loopnet for commercial) is less likely if you know specific brokers who can move specific properties.
8. The Rent Structure and Tenant Responsibilities Are Different In Commercial Real Estate
Most commercial investments are based on annual returns on rents calculated annually. So, if a commercial property is marketed at $12 per square foot, that is the annual rent, where residential is mainly marketed by monthly rent, so you’ll have to shift and get used to annual calculations. Also, some commercial rentals are considered net leases, meaning the tenant pays all expenses and maintenance for property. The rent is 100% net to the owner, even insurance. I always negotiate, when I represent tenants, that a landlord maintains the roof, walls, floors, and underground utilities. After all what is the landlord renting if not an intact structure?
9. Commercial and Residential Properties are Valued Differently
In general, the biggest difference between commercial and residential real estate investing is the way the property types are valued. Residential properties are nearly always valued based on comparing to similar residential properties, while commercial real estate is valued on the income from an investment perspective, which requires an understanding of different industry standards and financials. Some old-time investors calculate the worth based on multiples of rent. Most calculate value on a specific return interest rate.
10. Residential Properties Are an Emotional Acquisition
Comparing commercial and residential real estate is like comparing apples and oranges. Investing in commercial is a numbers game based on return on investment (ROI), while residential is based on how a property “feels” and is nowhere near as cut-and-dried. Residential purchases are typically a long-term personal and emotional investment based on the fact that a house feels right — ROI is irrelevant. One runs the risk of a neighborhood appreciating or depreciating.
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