Income Property vs. Commercial Real Estate

by Landon M. Scott

Welcome to the first post of my new blog. Let’s get right into it…

Are apartment buildings a form of commercial real estate or residential real estate?

I remember trying to convince a headhunter early in my career that my experience in multifamly qualified me for a hot lead she had for a large “commercial” broker in downtown LA. I wanted a crack at the position badly.

The only problem was that I couldn’t convince this confident human resource dynamo that multifamily assets are considered commercial real estate in the industry and that I therefore didn’t belong to the pool of applicants who only had “residential” experience, whom she was told not to consider for application to this particular job.

If the title of this post (Income Property vs. Commercial Real Estate) strikes you as calling out a distinction without a difference, and you can understand my frustration with Ms. Headhunter, congratulations – you can skip this post and await my next. If you think she had just cause to turn me down as a potential applicant, please, oh please, read on!

The term “commercial” real estate is an imprecise term used to distinguish property typically purchased for its ability to produce income (aka Income Property, or Income-Producing Property) from property that is typically used as a form of domicile or residence. It is true that some owner-users purchase income property such as retail, industrial or office buildings for their own use and therefore don’t derive income from a third party tenant, but for such assets there is a deep and liquid market amongst real estate investors who do purchase it to rent out and therefore generate an income.

Because income-producing property is typically leased out to a tenant and generates cash flow in the form of rent, the preferred way to value such assets by the lending, appraising and investment community is by the Income Approach. This is true whether third parties are using it as a residence, in the case of apartment buildings (aka multifamily assets), or whether third party tenants are using the property in question as a place of production or business.

In the proceeding blog posts I will use the terms “commercial real estate” and “income property” interchangeably, because the term “commercial real estate” is part of the common vernacular. But help me point out the meaning of commercial real estate to the lay audience when you encounter the term being applied erroneously. Some poor kid’s career prospects out there might just hinge on it….

PS – It is a fact that there is a significant degree of stigma attached to industry participants whose experience is limited to single family residences (SFR) and 1-4 units (a grey area between residential and commercial assets, though by my definition technically commercial but is considered by most, including myself, to be residential), as the learning curve is steep for those in residential who want to make the move to commercial real estate (I hope this blog helps those trying to lessen that curve); it is an understandably justified stigma. But beware the office/industrial/retail-leasing small timer who tries to capitalize on this stigma to qualify their credentials at the expense of those engaged in multifamily assets, which by the way are typically more complicated to value, particularly when Lower Income Housing Tax Credits (LIHTC) are placed on them. Most ironically, the metric these office/industrial/retail leasing brokers typically use is price per square feet, the same metric used for your single family residence!

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