Commercial vs. Residential: Leases, Valuation, and Risk
Commercial real estate (CRE) encompasses office, retail, industrial, multifamily (5+ units), hospitality, and specialty properties. Residential investment properties are typically 1–4 units governed by residential landlord-tenant law. The differences between these asset classes affect leasing, valuation, financing, and risk in fundamental ways. Lease structure: residential leases are typically 12 months, heavily tenant-protective under state law, and rarely modified from standard forms. Commercial leases are negotiated contracts that may run 3–20 years, with terms governing rent escalations (annual fixed increases or CPI-linked), tenant improvement allowances (landlord cash contributions to tenant build-outs), exclusivity clauses, co-tenancy provisions, and operating expense allocation. Triple Net (NNN) leases require the tenant to pay property taxes, insurance, and maintenance in addition to base rent — the landlord receives a predictable net income stream with minimal management. Gross leases have the landlord pay all expenses. Modified gross splits expenses by negotiation. Valuation: residential properties are valued primarily by comparable sales (what similar homes sold for). Commercial properties are valued primarily by the income approach (NOI ÷ cap rate) — a commercial building's value rises and falls with its rent roll, making tenant quality and lease term a direct driver of asset value. Vacancy risk in commercial is more concentrated: losing one anchor tenant in a strip mall or one major office tenant can devastate a property's cash flow and value simultaneously. Financing: commercial loans typically require 25–35% down, shorter amortization periods (20–25 years), and higher rates than residential investment loans. They are underwritten primarily on the property's DSCR (Debt Service Coverage Ratio = NOI ÷ Annual Debt Service) rather than the borrower's personal income.