Are Multifamily Properties Considered Commercial?

Classifying real estate properties is important for owners and investors, influencing financial, regulatory, and operational considerations. The distinction between property types, especially for those with multiple dwelling units, is often unclear.

Understanding Property Classifications

Real estate properties are categorized by primary use and income potential. Residential properties, like single-family homes, duplexes, or small apartments, are for individual or family living, intended for owner-occupancy or modest rental. They cater to housing needs, not business activities.

Commercial properties are used for business operations or income generation. This category includes office buildings, retail centers, industrial warehouses, and hotels. Their defining characteristic is generating revenue through business activities. While other categories exist, the residential versus commercial distinction forms the basis for most property evaluations.

Multifamily Properties: A Closer Look

Multifamily properties (apartment buildings, duplexes, triplexes, quadplexes) have a unique classification. While providing housing, their primary function is to generate income from multiple rental units, like a business. This income-generating nature leads to their classification as commercial properties, particularly with five or more units.

Smaller multifamily properties (one to four units) can be nuanced. They may be treated as residential for certain lending purposes, allowing conventional residential mortgages. However, these smaller properties are often viewed as commercial investments due to their income-producing intent. Classification depends on context, such as unit count or lender/zoning intent.

How Classification Impacts Multifamily Properties

Multifamily property classification impacts owners, investors, and developers, influencing financing, regulatory compliance, tax obligations, and valuation. Understanding these impacts is important for property management and investment.

Financing

Financing for multifamily properties differs by classification. Properties with five or more units require commercial loans, with different underwriting, rates, and shorter terms than residential mortgages. Commercial loans demand higher down payments (25-45%) and have 15-25 year amortization periods with balloon payments. Residential mortgages are available for 1-4 unit properties, with lower down payments (as low as 3%) and longer fixed terms (15 or 30 years).

Zoning Regulations

Zoning regulations dictate where multifamily properties can be built and their density. These properties are designated under specific multifamily or commercial zones, differing from single-family zones. Compliance is necessary for permits.

Taxation

Taxation is impacted by classification. Local property taxes for commercial properties, including larger multifamily buildings, may differ from single-family homes. Assessors use income, sales comparison, or cost approaches for tax valuation. For federal income tax, residential rental property owners can deduct depreciation over 27.5 years, as outlined by IRS Publication 527.

Valuation Methods

Valuation methods for multifamily properties mirror those for other commercial real estate. The income capitalization approach is employed, determining value by net operating income (NOI) divided by a market capitalization rate. This method emphasizes income generation, a primary investor consideration.

Insurance Requirements

Insurance requirements for multifamily properties are more extensive than single-family homes, requiring commercial property insurance. Policies cover general liability, property damage, and loss of rental income, protecting against lost revenue if uninhabitable. Specific coverages like equipment breakdown and business interruption are common for commercial multifamily ventures.