Upgrading a small multi-family to commercial?

Question

Hello BP fam!

Question for multi-family investors. Have you ever run into a situation where a small multi-family (1-4 units) was zoned and had the space for more units (5+)?

What happens to the financing then?

In this situation, there is a property zoned MF with one acre, enough space to add more than 4 (potentially 6 or 7). The property is zoned residential so I could get a primary residence loan on a small multi-family, but I'm wondering what would change, if anything, once I build more than 4 units? Will the lender force me to refi into a commercial loan?

Thank you!!

Lauren Robins · Answer

Yes, many multi-family investors do encounter situations where a small multi-family property (1–4 units) is zoned and has the space for more than four units. This can present a great opportunity for value-add development, especially if the property is already zoned for higher density, such as multifamily or medium-density residential. The financing, however, is where things can get tricky, especially if you plan to live in the property and initially qualify for a primary residence loan.

As long as the property has only 1–4 legal dwelling units, it qualifies for residential financing. This means you can use loan products such as conventional (Fannie/Freddie), FHA, or VA loans. These loans typically offer more favorable terms than commercial loans—lower down payments, lower interest rates, and 30-year amortizations. Additionally, if you’re living in one of the units, you can often take advantage of owner-occupant pricing and underwriting.

However, once you build and legally add more than four units—crossing into 5+—the property is classified as commercial real estate. That reclassification means residential loan products no longer apply. Even if you’re still living there, the financing is based on the nature of the property, not your occupancy. At that point, most lenders will require you to refinance into a commercial mortgage, which typically comes with higher interest rates, shorter loan terms (often 5 to 10 years), balloon payments, and underwriting based on the property’s income (typically through a debt service coverage ratio, or DSCR) rather than your personal income.

If you build the additional units while under a residential loan, your lender may enforce the “due-on-sale” or “due-on-transfer” clause—or simply require you to refinance due to the material change in property use. While not all lenders will monitor this proactively, if you're using construction financing or pulling permits under your name, it may trigger a review or prompt questions. You should speak with your lender or broker before starting any expansion to understand their policies and avoid surprises.

Some investors choose to phase their development—building up to four units first and waiting until they are ready for a commercial refinance before adding the remaining units. Others might use a HELOC, personal funds, or private lending to fund the expansion and delay or manage the transition to commercial classification. Regardless, if your long-term plan is to create a 5+ unit property, you should prepare for commercial loan terms and make sure the investment still performs under those conditions.

Ultimately, the shift from residential to commercial classification is a significant one in the eyes of lenders. While this kind of project can dramatically increase your property’s value and cash flow, make sure you’re working with a mortgage broker or lender who understands both residential and commercial lending so you can navigate the transition strategically.Note: This information is for educational and informational purposes only and does not constitute legal, tax, financial, or investment advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Martin D. · Answer

Thank you so much Lauren!! This confirms my instinct.

It's a great deal but you gotta think ahead. And I like the idea of building out 4 units in phase 1 and maybe building the rest at a later time, when there's a bit of appreciation in the property and qualify with a lower LTV for commercial purposes.