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Discovery Idea:

Residential to Commercial

In early 2019, I wrote a 3-part series directed towards residential agents interested in getting into commercial real estate. The following is a summary of the series.

Financing, including terms, is a major difference. A commercial investment property requires more money down (typically 20% for non owner-user properties), the loans have higher interest rates and are due in five years, not 30 (like a house, duplex, triplex or four plex). Commercial lenders may specialize by asset class. Examples of an asset class is senior housing, industrial, hospitality etc.

Investors and lenders focus on cost, value and price. The cost of a property may exceed its value meaning the materials in construction may be more than what the market will pay for the property (the price). This can happen with special purpose buildings or when owners overspend on a location.

The focus in commercial is financial. The money sunk into a property precludes them from deploying that same capital elsewhere. Then there are the holding costs over the course of the investment. Investors look for a rate of return on and of their capital. That is not the same view as in residential real estate and is likely why having a sense for numbers goes hand-in-hand for commercial real estate professionals.

Deal size and timing are different because commercial real estate tends to be priced higher than residential. Clearly, this is not always the case. There are plenty of homes in the $1.0 plus million range and dilapidated looking commercial property for sale in $500,000 range. However, as a general rule of thumb, commercial properties are larger and sell for more so those agents/brokers involved stand to make more in terms of commission.

Commissions can be in the 6% range for residential (3% to listing and 3% to selling) but in commercial these can drop to under 5%. Often brokers will negotiate a lower commission in order to get the listing and the phrase they use is "points." While I was working on an investment sales team for commercial property in San Francisco, I remember a 9-building portfolio of industrial buildings being shopped. Our team wanted the chance to represent the owners and our commission was under "1 point" or 1%. Of course, the value was in the $100 million range.

These types of transactions can take months, sometimes even years, to happen. It takes times to cultivate the relationships and build trust. Financing takes longer. Due diligence likely involves a team of experts. These are yet another reason pros like to work with other pros. The risk of a deal faltering, after working say half a year, inspires building a network of trusted brokers, agents and experts.

Due diligence is more extensive. Understanding this when getting involved in a commercial deal will help set the pace for how to navigate the hurdles. It is also why I suspect few agents are willing to jump from residential into commercial real estate; the exception possibly being commercial condominiums or small buildings. When I started my own appraisal/brokerage firm, we focused on "Main Street" properties and that is where I ran into many agents who were primarily residential but had a good relationship and therefore, ended up doing some commercial deals.

However, lack of experience with commercial deals can lead to some common mistakes. For examples the property's existing use might not be allowed by current zoning; this may impact the lender's ability to fund the loan. I remember clearly a Victorian house in San Francisco we were asked to appraise by a commercial lender. It was being used - with a special use permit - as a funeral parlor. The residential agent listing the property wasn't used to doing commercial yet this was actually a residential deal because the land was zoned for residential. Once the lender was notified of the issue, they immediately backed out of the loan.

In closing, structural differences between residential and commercial impact how a property is marketed and valued. It might be said that residential real estate is more qualitative in nature while commercial is more quantitative.