Residential vs. Commercial Real Estate Transactions
Scott Strasburg from Class-Harlan Commercial
Generally speaking, many might think that there aren’t many differences between residential and commercial real estate. People know that single-family homes, townhouses and condos fall under the residential category and that industrial, retail and office are commercial
However, the actual real estate transaction and process is very different between these two categories for a number of reasons.
Due Diligence vs. Inspections
In a typical residential transaction, the Buyer will usually opt for specific types of inspections, such as Building, Radon and Wood Infestation. Sometimes there could also be a septic, water, mold & stucco inspection as well. In the agreement of sale, the Buyer will ask for a specific number of days to do these inspections and to get the reports back for review and consideration
In a commercial transaction there is a due diligence period (DD). This is also negotiated as to the amount of time allowed, which is usually longer than the time-frame of a residential property. In the DD period, the buyer can do any and all inspections, but doesn’t need to specify the items to be investigated. At the end of the DD Period, the Buyer will simply notify the Seller if they are in or out of the deal, or re-negotiate items that surface in the DD period.
A Seller’s disclosure form is a document that is created to state any and all known issues or defects in a home. The legality of this document varies state to state and failing to disclose an issue can mean legal trouble down the road for the Seller.
A Seller’s Disclosure is required for any 1-4 unit residential property. A Seller’s disclosure is not required in a commercial transaction.
Terms and Conditions
Residential mortgages usually have a limit of an 80% Loan-to-Value (LTV) ratio although some specific mortgages allow for a 90% LTV or even higher with FHA/VA loans. The amortization time can be as high as 30 years.
A commercial mortgage will usually cap out at 70-75% LTV ratio with a 15-25 year amortization schedule and the interest rates will be about 1-2% higher than a residential mortgage. Sometimes there is a balloon payment where the mortgage must be paid off in 5 or 7 years and not the same term as the amortization schedule for residential properties. However, if a Buyer is a user and not an investor and is also looking to borrow money for his/her business, they can acquire an SBA loan (Small Business Administration) which has a 90% LTV ratio.
An appraisal is performed by a bank to determine the current value of a property. A typical residential appraisal costs about $350-500, and takes about 3-5 days. The cost of a commercial appraisal is anywhere from $900-3,000 and can take up to 3 weeks. One of the reasons for this higher cost is the result of adding and creating an income approach to value that is not included in the residential appraisal.
In a commercial transaction, where the Buyer is getting a commercial mortgage, the mortgage company will require a “Phase I” study. This study will evaluate prior uses, neighboring properties and on-site investigation to determine if there might be an environmental issue. If so, a “Phase II’ will be ordered where certain tests will be done to determine potential environmental issues and contamination.
A residential mortgage does not require any environmental studies. A Buyer can elect certain studies, but that is rare in a residential transaction.
Letter of Intent – LOI
When a Buyer wants to make an offer on a residential property, an Agreement of Sale is created and presented to the Seller. Many times in a commercial deal, a Letter of Intent is submitted to briefly outline the terms and conditions. Once that has been agreed to, an Agreement of Sale or Lease reflecting those terms is created- typically by an attorney. The LOI is not binding and a specific time frame is put in the LOI outlining the time both parties have to execute one of these documents.
In general, there are several differences in the psychology of buyers and sellers for residential property vs. commercial properties. In both types of property, location is usually the most important aspect to be considered.
Many times, when people are purchasing or selling residential property, some emotion is involved with the deal. It might be because it was their first home, where they raised their family, where they were able to take care of extended family at an important time in their lives and it might be a place where they made many friends.
In a commercial deal, after location, it’s basically math; especially for investors. How big is the building, how many parking spaces are required, how many drive-bys are there on a daily basis, what are the rental rates, what is the cap rate, etc., are all questions and considerations being analyzed and vetted during commercial transactions
These are some of the differences between residential and commercial transactions. There are many aspects involved and it is helpful to talk with a professional about going forward with either of these acquisitions.
If you have any questions or are interested in purchasing or selling a residential or commercial real estate, give Class-Harlan Real Estate a call. Click here to contact us today.