Is Multifamily Considered Commercial?

Understanding real estate classifications is important for property owners, investors, and anyone navigating the market. A common question concerns whether multifamily properties are residential or commercial. This article clarifies the characteristics of multifamily and commercial properties, explaining how multifamily assets are categorized within the broader real estate landscape.

Defining Multifamily Properties

Multifamily properties are real estate structures designed to house multiple separate residential units within a single building or across several buildings. These properties accommodate more than one household, providing distinct living spaces for each. They fundamentally involve multiple tenants, contrasting with single-family homes that house only one household.

Multifamily properties vary in size and configuration. Smaller examples include duplexes (two units), triplexes (three units), and fourplexes (four units). These smaller properties might feature units side-by-side or stacked. Larger properties encompass apartment buildings and complexes, which can range from a few units to hundreds, often featuring shared amenities like parking, laundry facilities, or recreational spaces.

These properties typically generate rental income from the individual units. While their primary use is residential housing, the presence of multiple units and the income-generating aspect introduce considerations beyond those of a traditional single-family home. Management and maintenance requirements for multifamily properties differ significantly from single-family residences due to their scale and the number of occupants.

Defining Commercial Properties

Commercial properties are real estate assets primarily used for business activities or to generate profit through rental income or capital gains. These properties are not intended for private residential living but rather for commercial operations. Their purpose is to facilitate commerce, industry, or other income-producing ventures.

Examples of commercial property types include office buildings, which provide workspace for various businesses, and retail spaces, such as shopping centers, standalone stores, and restaurants. Industrial properties like warehouses and manufacturing facilities also fall under this classification. Hospitality venues, such as hotels, are also considered commercial properties due to their income-generating nature.

Commercial properties are typically leased to business tenants, often with longer lease terms than residential rentals. The valuation and financing of commercial properties are generally based on their income-generating potential, distinguishing them from residential properties that are often valued primarily on comparable sales.

Multifamily as Commercial Property

Multifamily properties are generally considered a subset of commercial real estate for most practical purposes, especially concerning finance, investment, and larger-scale transactions. This classification often depends on the number of units. In the United States, properties with two to four units are typically classified as residential, while those with five or more units are almost always considered commercial.

The rationale for this classification centers on the property’s primary purpose and scale. When a multifamily property contains five or more units, its profit-driven nature becomes more pronounced, requiring different financing, management, and maintenance approaches than smaller residential properties. Even smaller multifamily properties, like duplexes or triplexes, can be treated as commercial by investors or lenders if their main objective is income generation rather than owner-occupancy.

This distinction reflects the income-producing nature of these larger assets, which are valued based on their ability to generate revenue. The financial models and investment strategies employed for these properties align more closely with those used for other commercial assets. The commercial designation also applies because such properties typically necessitate more structured, professional management and maintenance due to their complexity and scale.

Practical Effects of Classification

The classification of multifamily properties as commercial has several practical implications, affecting how properties are financed, regulated, valued, and taxed. Understanding these distinctions is important for anyone involved with multifamily real estate.

Financing for commercial multifamily properties differs significantly from residential loans. Properties with five or more units require commercial mortgages. Unlike residential loans focusing on personal credit, commercial loans primarily assess the property’s income-generating ability. Lenders evaluate this through metrics like the Debt Service Coverage Ratio (DSCR), calculated as Net Operating Income (NOI) divided by Debt Obligations. Lenders prefer a DSCR of 1.20x or higher to ensure the property can comfortably cover its debt payments.

Zoning and regulations also change with commercial classification. Larger multifamily developments often fall under commercial zoning ordinances. These involve different building codes, density requirements, and permitting processes than residential zones. Such regulations impact the property’s design, construction, and operational aspects, influencing factors like unit allowances and amenity types.

Valuation methods for commercial multifamily properties rely on income-based approaches. Instead of comparable sales, commercial appraisals use metrics like capitalization rates (cap rates) and gross rent multipliers. The capitalization rate is calculated by dividing the property’s Net Operating Income (NOI) by its current market value, indicating potential annual return. A good cap rate for multifamily properties typically falls within 4% to 10%, though this varies by market and property class.

Tax treatment for commercial multifamily properties also presents distinct characteristics. Owners can deduct various operating expenses, including mortgage interest, property taxes, insurance premiums, and routine repairs. Depreciation is another significant tax deduction, allowing owners to deduct the building’s cost (excluding land) over its useful life. For commercial properties, this period is generally 39 years, while residential rental properties typically depreciate over 27.5 years. Professional fees for property management, legal, and accounting services are also deductible.