Although I’ve written a number of blogs on the various aspects of commercial real estate, such as commercial subleases, sale/leasebacks and OPEX pass throughs, I thought it would be a good idea to go back to the basics for those who have an interest, but not the experience, in commercial real estate. In this blog post, we will cover commercial vs residential real estate and discuss the differences between the two, which are much more than the similarities they share.
Below, we’ve highlighted the five key differences between commercial and residential real estate:
- Emotional investment (or lack thereof)
One fundamental difference between residential and commercial property is the buyer’s emotional connection to it. Most residential real estate is purchased or leased with an emotional factor involved, while commercial properties are viewed more for their utilitarian value. A home purchaser may like the way a house is situated on a lot, while a commercial purchaser is more concerned with the number of loading docks, the ceiling height, or the number of trailers that can be parked on the property.
- Deal complexity
A main difference between commercial and residential real estate is in their respective negotiations and contracts. Commercial real estate transactions are much more complicated than residential ones. If you’re selling a house, typically, setting a selling price is fairly simple: you’ll use comparable homes that were sold in the area over a period of time to determine a fair price. When selling a commercial building, however, the rental income, length of lease(s) on the building, and operating/maintenance expenses are all factors in determining the selling price. A related issue is the difference between a commercial and residential real estate agent – they have varied experience to handle the distinct complexities.
- Length of sale
Another divergence between commercial or residential real estate investing is the time the sale takes from start to finish. In the residential market, a buyer can view four or five homes over a weekend, like what they see, and make an offer. In New Jersey, there’s a three-day attorney review window for the contract, and most people are already pre-approved for a mortgage before they even start looking at homes – all of which can help make closing happen very quickly. Commercial properties, however, take much longer to close. A purchase and sale agreement can easily be 50 pages long, typically taking a month of negotiation; and due diligence can take as long as six months, in some cases!
- Laws concerning tenants
An interesting, yet subtle, difference between commercial and residential real estate is how the law views residential versus commercial tenants. Residential tenants have many rights that don’t apply to commercial tenants. Most notably, it’s much easier to evict a commercial tenant than it is a residential one. The law always leans in favor of the residential tenant; but in a commercial transaction, it is viewed as an agreement between two equals, and what’s in the contract or lease is what both parties have negotiated. It’s then up to a judge to decide who is right.
- Rental structure
When discussing commercial real estate vs residential real estate, commercial leases will either be a net lease – where the tenant pays all the expenses of operating a building, including real estate taxes – or a gross lease – where those costs start with a base for the year, and any increases in cost are passed on to the tenant. With most residential leases, all of those items are included. If a drain is clogged, the tenant calls the landlord to get a plumber; they don’t fix it themselves.
- Emotional investment (or lack thereof)
The differences between residential and commercial real estate are many, and if you plan on investing in commercial properties, you’ll need to be prepared to compete against people who do this for a living and who usually specialize in a particular segment of the commercial market. But McBride can help with our commercial real estate consulting services. In our next blog, I will discuss those segments and the various types of commercial properties. Stay tuned!