Is it commercial or is it residential?

16 Replies

So, I’m looking at a large house in my local area that has 5 units with 5 separate electricity meters. The MLS is marketing it as a multifamily residential property and was valued based on comparable homes. I was curious if banks or loan companies would still consider this residential, since its technically has 5 units? And if not, is it possible or beneficial to convert the house into a commercial property so I could raise the NOI and increase it’s overall value? Please help! Thank you

@Eric Kristt - if it is legally zoned a 5 unit it is commercial and the list agent doesn't know what they are doing and thinks you value it based on comps 

I think it was zoned as residential but I’m not 100% sure. It is a house, just very large and split into 5 units. Does that matter though? Could I buy it as a residential and then zone it as commercial afterwards? Maybe that would be a great was to make money if they are just making a classification mistake...?

Originally posted by @Eric Kristt :

I think it was zoned as residential but I’m not 100% sure. It is a house, just very large and split into 5 units. Does that matter though? Could I buy it as a residential and then zone it as commercial afterwards? Maybe that would be a great was to make money if they are just making a classification mistake...?

 It can be zoned residential, and for city/county purposes it may even be residential, but for financing purposes it's commercial. A kid can be grounded according to mom but not grounded according to dad, one of those things. Or if it's Europe in the 19th century it can be November in Russia and October in the UK, on the exact same day. This property is residential according to the city, but commercial according to mortgage lenders.

Check it's zoning at the town, in fact most have it available on-line. 

Commercial zoning can also get you into a higher property tax bracket along with commercial rate trash pickup. We are required to pay that quarterly in addition to the 'trash tax' already included on our property tax bill. Also be prepared for the need to retrofit Fire Sprinkler & Fire Alarm systems as per the 2015-2017 IEBC code requirements that some towns are starting to enforce. It would be a very expensive mistake to ignore these new code requirements. 

But is the increase in property tax and garbage worth the increase in value by zoning it commercial? I’m looking at the property thinking if I can raise the rents, improve the property with some basic rehab and make it commercial it would be worth a lot more at the time of selling? Is that correct thinking?

I don't know your area, in mine we have zoning certificates which are required on all properties, and it will tell the legal number of units.  I have had a legal 4 unit with 6 total units get residential financing before 

Originally posted by @Eric Kristt :

But is the increase in property tax and garbage worth the increase in value by zoning it commercial? I’m looking at the property thinking if I can raise the rents, improve the property with some basic rehab and make it commercial it would be worth a lot more at the time of selling? Is that correct thinking?

Commercial value = NOI / market cap rate

Residential value = comparable sales

Eric, which is higher?  You may find them to be similar (or not).  The market cap rate is determined by comparable sales too.

Mike, that’s what I’m saying.... they used comparables to generate its value. But I think if you used the noi/cap it would have been valued much higher. My question though is can I purchase it as a residential (valued by comparables), then in 5 years sell it as commercial and use my ROI to value the property and market it with a higher value? Maybe I could rezone it....

Originally posted by @Eric Kristt :

Mike, that's what I'm saying.... they used comparables to generate its value. But I think if you used the noi/cap it would have been valued much higher. My question though is can I purchase it as a residential (valued by comparables), then in 5 years sell it as commercial and use my ROI to value the property and market it with a higher value? Maybe I could rezone it....

 If you can market it and sell it as commercial, then yes that might be viable. I don't think this is a zoning thing, however, I think it's a marketing thing. It's not inconceivable to me that the same property marketed as commercial and catching the attention of commercial RE agents might sell for more. But, again, this is about marketing not zoning. Basically you'd be betting that you are right and the listing agent screwed the pooch. 

Originally posted by @Eric Kristt :

But is the increase in property tax and garbage worth the increase in value by zoning it commercial? I’m looking at the property thinking if I can raise the rents, improve the property with some basic rehab and make it commercial it would be worth a lot more at the time of selling? Is that correct thinking?

  if it gets zoned commercial , then you cant rent it out as apartments . 

Originally posted by @Eric Kristt :

Mike, that's what I'm saying.... they used comparables to generate its value. But I think if you used the noi/cap it would have been valued much higher. My question though is can I purchase it as a residential (valued by comparables), then in 5 years sell it as commercial and use my ROI to value the property and market it with a higher value? Maybe I could rezone it....

I understand. I don't why an investor would pay more per door for the NOI of a 5-plex (commercial financing) vs the NOI of a 4-plex (with residential financing).

Said another way, the market cap rate for a 5-plex could be very similar to the calculated cap rate of a 4-plex.

1-4 = Conventional loan options

5+ = Commercial loan required

The residential title versus commercial title may be to clarify that it is rental units, and not commercial office space, or commercial retail.  The agent should have clarified Commercial residential or commercial multi-family, but clearly they may be lacking some experience in the commercial field.

This may be a good opportunity for you to swoop in and get a good commercial multi-family deal if the numbers work for you.

Eric, zoning it commercial versus residential has nothing to do with what you can collect for rent.

If a comparable two bed is renting for 1000 in your area then it will rent for 1000 no matter the zoning.

Tenants don’t know, or care, how the property is zoned.

Frank, the question about zoning was not can I increase rents bc it’s zoned differently. The question was can zoning the property as commercial help to increase the total value of the house at the time of selling....?

@Eric Kristt   As others have stated, financing will be commercial because it is over 4 units. For tax purposes it is a residential rental property. The value should be based on cap rate and condition. You could compare it to a 4-plex. The main difference is that over 4 units, it can't be owner occupied. That limits the market to only pure investors, many of which who are looking for larger buildings. That could subtract from the per unit value over a comparable 4-plex.

Zoning really varies by area. Generally speaking, commercial zoning opens up more possibilities for better use of the land, but that is the biggest advantage I can see. Disadvantage could be a location on a busy street which is less popular for residential, but would be great for a store-front. Zoning can introduce restrictions or open up possibilities. I would research what makes the most sense. I have seen entire city blocks rezoned to commercial and knocked down for a strip mall, so the land can become more valuable, but depends on location.

@Eric Kristt anything above 4 unit is considered a commercial.  Please note that there are tons of rules and regulation from all over different county that are more stricter if you have mutifamily house/buildings that are more than 4 unit.  Some examples are boiler inspection, in NYC, it needs to be check every year and if you don't then there is a 1000 dollar fine.  Also if for any "security deposit" you will also need to have it put into a special escrow account, if it collects interest you have to return the interest with the security deposit.

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here