Is multifamily considered residential or commercial?

Multifamily properties, encompassing properties from duplexes to apartment complexes, are a unique category in the real estate sector. Multifamily properties are distinct in that they contain multiple, separate living units within a single building or a complex. Despite their primary function as residential spaces, multifamily properties are classified as either residential or commercial based on specific criteria.

In this comprehensive guide, we examine the factors that determine their classification as residential or commercial. We also look at how the classification influences financing, taxes, and property management. By understanding the differences and implications of these classifications, investors and property managers can make informed decisions when navigating the multifamily property landscape.

Residential vs. Commercial: Categorizing multifamily properties

The categorization of multifamily properties as residential or commercial isn’t always straightforward. Various factors can impact whether a multifamily property is considered commercial or residential.

Here we explore the factors that influence how to classify a multifamily property and the implications of the classification:

Residential property classification

Before categorizing a multifamily property, it is important to understand the difference between residential and commercial property. A residential property is a type of real estate that is primarily used for housing people. This category includes a wide range of housing types, each designed to accommodate living spaces for individuals, families, or groups of people. Residential properties often have different financing, tax, and regulatory requirements than commercial properties, reflecting their primary role as personal living spaces.

Commercial property classification

Commercial properties are intended for business operations and profit generation. This category includes office buildings, retail spaces, warehouses, hotels, and multifamily properties. The management, maintenance, and legal considerations for commercial properties are typically more complex due to their business-oriented nature and larger scale.

Grey areas

Multifamily properties introduce a unique challenge when it comes to classification as they serve a dual purpose. Multifamily properties are designed for residential living; however, they are also intended to generate a profit for the property owner or investors.

Differentiating between residential and commercial multifamily properties is commonly based on the number of units. Multifamily properties with 2-4 units are typically classified as residential. The property still has the intent of generating a profit for the property owner, however, it will be less than a commercial multifamily property.

When a multifamily property has 5 or more units, it is generally classified as commercial. These properties are deemed commercial because they are expected to have higher returns based on the higher number of units available to rent. The commercial designation is also because such properties usually require different financing, management, and maintenance approaches.

So, is multifamily considered commercial or residential based on the number of units? While the number of units in a multifamily property is an important classification factor, it’s not the only factor to be considered. Local zoning laws and the presence of commercial features like retail spaces or offices also play significant roles in determining whether a property is classified as residential or commercial.

Zoning laws and multifamily property classification

Zoning laws dictate how land and buildings can be used within specific geographical areas. Zoning laws are designed to align property usage with the intended character of the surrounding area and promote a harmonious balance between residential and commercial spaces within the community.

This means the zoning designation of the multifamily property’s location will play a crucial role in determining its classification. If a multifamily property is situated in an area zoned exclusively for residential use, it is more likely to be classified as residential. If the property is located in a commercial zone, it may lean toward a commercial classification.

What are the implications of categorizing multifamily properties?

The classification of multifamily properties as either commercial or residential carries significant implications for property managers and investors.

Here are some of the key considerations:

Financing

The classification of a multifamily property can impact the financing options available. When a multifamily property is classified as residential, it often qualifies for residential loans. These loans typically offer lower interest rates and longer repayment terms compared to commercial loans. This can make financing more accessible and affordable, often resulting in first-time investors choosing residential multifamily properties.

For commercial multifamily properties, the financing options are generally commercial loans. Alongside the higher interest rates and shorter repayment terms, these loans often require a larger down payment and have stricter eligibility criteria. The lender’s evaluation process for these loans is usually more complex, focusing on the property’s income-generating potential.

Property taxes

Property tax rates can vary based on classification. Generally, residential properties tend to have lower property tax rates compared to commercial properties. The higher tax rates for commercial multifamily properties are an increased expense that can affect the profitability margins. This often leads to higher rents to maintain revenue for commercial multifamily properties.

Regulations

Compliance with local regulations and building codes may differ based on the classification of a multifamily property. Property owners and managers must be aware of and adhere to relevant laws and regulations specific to their property’s classification to ensure legal and operational compliance.

Property management

The classification of the multifamily property can impact the need for a property manager. For residential multifamily properties, hiring a property manager is often optional. Owners of these smaller properties sometimes choose to manage the property themselves, especially if they live on-site or nearby.

Even for these smaller multifamily properties, hiring a property manager can be beneficial. A property manager will run the day-to-day operations, ensure professional handling of tenant relations, and provide expertise in legal and regulatory matters. This is particularly valuable for owners who have multiple properties, live far from the property, or prefer not to deal with the day-to-day tasks of property management.

For commercial multifamily properties, having a property manager is almost a necessity due to the complexity and scale of the operations. These larger properties require more extensive management efforts, including handling a larger number of tenant issues and maintenance of common areas and amenities.

The rise of multifamily property software has significantly impacted the management of multifamily properties. This software solution offers tools for tenant screening, rent collection, maintenance requests, and financial management. They also often include multifamily AI to provide enhanced security, operational efficiency, and insights for decision-making.

Maintenance

The classification of a multifamily property as residential or commercial significantly impacts its maintenance needs and costs. Residential properties generally involve simpler, lower-cost maintenance. The scale of these properties allows owners or managers to address maintenance issues on a case-by-case basis. In many cases, owners who live on-site or nearby choose to handle maintenance tasks themselves.

Commercial properties require a more structured, professional approach to maintenance due to their complexity and scale. This often results in higher multifamily maintenance costs for commercial multifamily properties. Due to the complexity, commercial properties typically rely on professional property management teams to handle the ongoing maintenance needs.

Common misconceptions about multifamily property classification

There are common misconceptions about multifamily properties that can lead to confusion and misclassification.

Below we address some of these misconceptions to provide clarity on this complex issue:

Size determines classification

It is a widespread misconception that a property’s size alone determines its classification. While larger multifamily properties may have a higher likelihood of being commercial, size alone is not the sole determinant. Zoning laws, intended use, and the property’s individual characteristics play pivotal roles in classification.

Mixed-use equals commercial

Another common misconception is that a multifamily property with mixed-use components, such as retail spaces or offices within the complex, automatically qualifies as commercial. The primary function of the property and adherence to local zoning regulations are more important in determining its classification.

Number of units matters most

The number of units in a multifamily property is not the only classification factor. The primary use of the property, local zoning laws, and how the property is operated all significantly contribute to its classification.

FAQs about multifamily property classification