Property investors often turn to hard money lenders for help obtaining new properties. But most lenders are very choosy about the projects they are willing to invest in. Take a multi-unit apartment building. Some lenders would be happy to finance it and others would not give the project the time of day. Some of the disparity between lenders boils down to whether the property is classified as commercial or residential.
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No Interest in Residential Properties
Actium Partners is a Salt Lake City hard money lender specializing in real estate funding in Utah, Colorado, and Idaho. The firm does not get involved in residential projects. That means no fix in flips. But they do lend on commercial real estate.
A few years ago, they were asked to finance a multi-unit apartment property. They approved the borrower’s loan despite their firm commitment against lending for residential properties. Did they violate their own policies, or are we missing something here?
No, Actium did not violate its policies. The property was classified as commercial property based on the total number of units it contained. It was also not a case in which the buyer was purchasing a single house with the plan of living in one unit and renting the rest.
How Multi-Unit Properties Are Classified?
The previously mentioned property was used for residential purposes by the tenants who live there. From their perspective, there was nothing commercial about it. But their perspective is irrelevant in terms of classifying properties for taxes, zoning, and lending purposes.
Although there may be local exceptions to the rule. Here is how multi-unit properties are normally classified:
- Residential Multi-Family – Properties with between 2 and 4 units. More often than not, these are single homes that have been divided into smaller apartments.
- Commercial Multi-Family – Properties with 5 or more units in total. These could be either single buildings or a collection of buildings, just as long as the total units add up to 5 or more.
In the previously mentioned example, the property definitely contained more than the required number of units to be classified as commercial. The fact that the borrower would be treating his investment much like a business investment only added to the commercial nature of the transaction.
Financing the Different Properties
Correctly classifying a multi-unit property is important for several reasons. It is certainly important for financing, because commercial properties are harder to finance than their residential counterparts.
Imagine you inherited a large, urban property from your grandparents. It was the house your father and his siblings grew up in. Its size and location would make it ideal as a rental property, so you convert it from a single-family dwelling to a 3-unit apartment property.
Should you decide to sell the house years from now, a buyer could finance it with a conventional mortgage. Because it is classified as residential multi-family, a bank would have no trouble financing the purchase.
Banks are a lot more reluctant to get into commercial multi-family properties. They might still be willing to lend, but it takes a lot more convincing. That is why commercial property investors are more likely to turn to hard money lenders.
Is All About the Units
The line of distinction for classifying multi-family properties is the total number of units. To me, it makes perfect sense. A property with 10 units is clearly being purchased as a business investment. On the other half, a subdivided single-family home is less of a business and more of a personal investment. I don’t know for sure, but perhaps lenders see things the same way.
