Before the 20th century, the majority of real estate offerings were either single-family homes or small apartment buildings, with little to no distinction between commercial and residential properties.
However, as populations and cities grew larger, the need for more housing increased. After World War II, larger apartment buildings and complexes began to pop up in more urban areas, funded by investors or corporations.
It wasn’t until a few decades later that lenders and banks made a formal distinction between commercial and residential multifamily properties based on the number of units.
What is the magic number?
The dividing line falls between 4 and 5 units.
To most banks, buildings with four units or fewer are typically considered residential properties, while buildings with five or more units are considered commercial properties.
Why does this divide exist?
The reason for this divide is mostly due to financing. Banks consider residential multifamily properties to be less risky than commercial properties, making them subject to different lending guidelines.
More tenants mean higher risk of vacancy in a commercial property, not to mention higher maintenance costs.
Another reason this separation happened in the 1960s and 70s was zoning regulations, which added restrictions on the types of housing that could be built in certain areas.
While the justification for creating this divide along four and five units may seem a bit arbitrary, in today’s market, the distinction between commercial and residential multifamily properties runs deep in the real estate industry.
Many lenders and investors often choose one category and stick to it.
From a lending and investor standpoint, the closer you stick to the commercial market, the more complexity there is around financing.
However, this could potentially result in higher returns for investors willing to address this part of the lower-middle market.
Do you think this dividing number is still relevant today?
How might this distinction impact real estate investments and financing decisions?
