Commercial V. Residential Real Estate Investing: The Basics

What's the difference between a commercial apartment building and a residential building? Some people hear the word commercial and they start thinking of strip malls and office buildings, but multi-family buildings are commercial properties too. They just must have five or more units. A residential building consists of a multi-family building from one to four units.

As an investor, why does this matter? In a nutshell, financing. A lender looking to finance a commercial building will look first to the cash flow and net income of the building. The idea is that the owner runs a commercial building like a small business. This is obvious when you're looking at a building or complex with 10 units, 20 units, or many more. It's not as obvious when you're looking at a six unit building. The lender then usually will look at the experience of the investor, before moving on to his credit history and other personal factors. The bottom line is that if you find a good building at a good price, you should be able to get a loan, even in today's difficult environment.

Furthermore, a commercial lender will be looking at you to put at least 25% down, if not more. The loan may be assumable in many cases and there may even be pre-payment penalties and balloon payments. Your rate is probably going to be a little higher as well. Lenders can get creative here because the investor should be more experienced.

For a residential building, the lender will first look to the credit history and income of the investor. Only then will they look to the leases in place. While an investor in a commercial building can show the profit and loss statement, a residential investor will probably only get credit for 75% of the money coming in from the leases. The lender will need to make sure that the investor has enough outside income to cover this. Remember, this is a rule of thumb, it's not sketched in stone.

Don't forget the legal structure as well. Your residential building will probably be owned by you, personally, and be covered with personal liability insurance. A commercial building will more often than not be set up in a LLC or other self-contained entity. You should think this through before purchasing and have much of this in place before entering your due diligence phase.

The decision on whether to get a commercial building or a residential building depends on your goals and abilities, financially and otherwise. Just keep in mind, if you decide to purchase commercial buildings, you are now a small business owner. Start thinking like that and you should become more successful.