Is Commercial Real Estate Different Than Residential?
Written By Mark Hulsey, Managing Broker
For all of us working in the real estate industry, it’s a common question about the difference between commercial and residential. And it’s a great question that can really benefit a residential agent to understand. Some agents may think that all real estate transactions are created equal, but that’s not true once you cross the line into commercial deals.
Commercial real estate is complicated. So is residential. However, the distinctions between the two brokerage disciplines are many including valuation, marketing, financing, due diligence, title, and the people involved. Here’s just a few examples in key areas:
Property valuation methodology is one fundamental difference between commercial and residential real estate. Valuing a single family home is primarily based on market analysis or a CMA. While commercial also relies on market comps (usually measured on a PSF basis), income analysis is the cornerstone of valuation for most commercial buildings. Even on an owner-occupied commercial property, it’s important to know not only how much that ‘product’ is currently trading for PSF, but also market income expectations. With income understood, expenses are quantified to arrive at NOI or net operating income. Other key financial measures including cap rate, cash-on-cash returns, or discounted cash flow or debt service models can also be studied. Finally, the market versus income analysis is reconciled to establish a disposition value opinion. As you can imagine, this level of commercial asset valuation work is no small task if you’re doing it right.
In this seller’s market, It seems like a residential agent doesn’t need to do much more than win the listing, get pictures, throw it on the MLS, and watch the offers roll in. Of course that’s an over-simplification, but the MLS does seem to do a lot of the heavy-lifting in residential real estate marketing. When marketing commercial assets, not only is the marketing brochure (or Offering Memorandum, OM) more comprehensive and time consuming to build than a home flyer, but commercial real estate requires its own set of proprietary web-based, marketing & advertising platforms. This often comes with hefty fees to not only gain access to data, but to ‘feature’ your listings so they you don’t get lost in the clutter. Even property signage can be a very expensive challenge in marketing commercial properties. Bottom line, marketing commercial assets requires very tight listing management systems and the people to run them.
It’s interesting to hear more people lately use the term due diligence in their everyday conversations. In all real estate sales, a thorough understanding of the due diligence process is essential. In most home sales, there are often a few hurdles that must be overcome as part of the due diligence process including the home inspection, testing for radon or lead, or financing/appraisal approval. In commercial brokerage, common due diligence items include detailed review leases and P&L statements, ALTA survey, physical inspections, Phase I or II environmental reports, geotechnical studies, as-built floor plans, zoning use verification or conditional use permit (CUP), financing approval, estoppel certificates…and the list seems to go on and on. Due diligence on commercial deals can be a complicated and demands attention to detail.
Commercial brokers and residential agents alike must deal with their respective reputations & stereotypes in the marketplace. It’s sometimes said that commercial brokers are not the most inviting people to do business with. Sometimes described as an ‘old-boy’s network’ that does not want to let anybody in. While that’s certainly an exaggeration, there’s some truth in there too. But that’s largely based on one’s experience with commercial transactions. Many commercial brokers in larger markets do not believe in residential agents selling their product. Many would say that they would never consider selling a house because they know nothing about home sales even though they’re a real estate professional, so why do some agents that sell homes believe they should broker commercial assets? Why should they be paid a commission when they don’t know what they’re doing? There’s the rub. But one that can be silenced with education & experience (and a little humility can go a long way too).
Other notable differences between the residential home sales and commercial real estate include how we must disclose information, touring of properties, qualifying buyers & tenants, interacting with attorneys for nearly all transactions, very long sales cycles, negotiation of fees, and state statute considerations.
All real estate sales professionals require a lifetime of learning to stay at the top of our game. We’re fortunate to work in an industry with unlimited earning potential while still helping people along the way with some of their most important life and business decisions regarding where they live and work.
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