Basics of Property Management: Screening Potential Tenants

3 Ways Commercial Real Estate Is Different From Residential Real Estate

22 August 2022

Jesse Obrien

Comparing commercial real estate to residential real estate is like comparing apples to oranges. They are both fruit, but that's where the similarities end. Buying commercial realty requires working with a real estate agent with a completely different license and skill set. Here are three more key ways the real estate types are different.

Valuation

Residential real estate is all about location, location, location. Commercial real estate, however, plays by a different set of rules.

Residential real estate agents will tell you to look at comparable properties in the area to determine the price of a home, commonly referred to as 'running the comps.' The sale prices of other homes in the area determine the fair market value based on location, square footage, and the number of bedrooms and bathrooms. Two identical houses on the same street should sell for approximately the same price.

On the other hand, commercial real estate investments are valued strictly by their revenue stream. While the location is important with any purchase, it does not influence value in commercial realty. A commercial property's revenue from rental income is the main factor determining value. Two identical commercial buildings will sell for vastly different prices if one has leases in place with 100 percent occupancy and the other has below-market leases and a history of vacancy.

Lease Term

The lease term is very different for commercial realty as well. Residential real estate typically uses a one-year lease. An investor may even have a month-to-month plan or use an STR strategy. STR stands for short-term rental and refers to renting a home for less than 30 days at a time, like a weekly vacation rental.

Commercial real estate investments typically have much longer leases, up to ten years. While this is beneficial for the landlord to prevent vacancy, it is also helpful for the tenant. No one wants to move an entire business annually.

Net Operating Income

As a real estate investor, NOI, or net operating income, is crucial. With residential investments, there are many expenses to account for, including:

• Taxes
• Insurance
• Utilities
• Upkeep and repairs
• Vacancy

With commercial realty, an NNN lease is fairly common. NNN, or a triple net lease, means that the tenant pays for the taxes, maintenance, repairs, and all utilities in addition to rent, leaving the mortgage payment as the only real expense for the landlord.

NNN leases are beneficial because they offer stability and predictability for the investor. They know exactly what their cash flow will be each month, making it easier to budget and plan for future investments.

Now that you understand the key ways commercial real estate is different from residential, you can start looking for your next investment property. Be sure to work with an experienced commercial real estate agency such as RE/MAX Commercial Investment Realty to get the best advice and representation.

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