The Differences Between Residential and Commercial Brokers

On the face of it brokers who focus on residential and those who focus on commercial properties do basically the same thing, right? So, why would a broker specialize in one or the other? Or as a buyer why pick one over the other? 

While it is true that both types of brokers do basically the same thing, sell property, the similarities literally end there. The market, transaction process and consumer demands of commercial and residential real estate dictate significantly different education, experience and temperament.

For this discussion I will set aside smaller communities, generally well under 100,000 people, where there simply is not enough commercial property to justify specialization and the majority of brokers will do both categories.

The Basics

Let’s begin by looking at the differences between residential and commercial properties which can help provide insight as to why specialization might be a good thing.

Residential real estate is generally limited to single family homes, duplexes, triplexes and fourplexes. These properties all share the primary function of being places where people live. The buyers are largely the primary occupant of whatever building is being purchased. While there are investors that specialize in residential properties they represent a small percentage of the overall transactions and in many cases are brokers themselves.

Commercial real estate includes larger apartment buildings (4 + units); retail properties; office properties; industrial and self storage properties. All of these, except apartment buildings, are built and maintained as the primary location for businesses of one type or another. Most will rarely see anyone living in them unless there is a repurposing (industrial to apartments, etc). Apartments being the exception, however, even here you will never see the owner of the apartment building actually living at the property.

This difference, Residential being where you live and Commercial being where you work, cannot be overstated. People think very differently about their homes than they do about their workspaces. This difference shapes the brokers that specialize in each discipline.

Broker Focus

Residential brokers by and large are focused on the visual appeal of a property; the kitchen & bath layout; interior design and materials. generally looking to answer the question: ” would I like to live here.” Buyers typically spend less than fifteen minutes walking through a home before making a decision as to whether they want to buy it. In general residential buyers – and brokers – will not even turn on a sink to see if there is actually water running at the home.

Commercial brokers are focused on the functionality of a particular property, both physical and financial, above all else. Generally looking to answer the question: “will this work for my business or investment goals.” Buyers in commercial deals will generally do an initial evaluation of a property to determine viability before even setting foot in it. For business viability everything from local zoning to the size of the water tap can be reviewed to determine if the property could be a fit. When considering a property for investment most investors will add into their initial evaluation at least a rudimentary financial analysis if not a complete financial model to determine viability.

Even More Specialization

In larger cities, above ~200,000 people, you will find brokers that actually specialize in a specific type of commercial property. For instance, brokers who make their entire career mastering the details of only industrial properties in their markets. These specialists are invaluable to the market as their understanding of the unique details of a particular subtype of real estate can prove a requirement for success.

In most larger cities you can find brokers going even a step further in specialization, focusing completely on one particular niche of a type of property. Restaurants, for example, will generally have at least one brokerage firm that specializes in just doing leasing and sales of restaurant properties. Again the value of this kind of focused broker to sourcing the best spot for a restaurant can make an enormous difference to the businesses.

Conversely in residential you only occasionally come across firms that specialize in a particular product, condos for instance. However, it is far more typical for firms to specialize, if at all, along financial lines. Focusing on properties under $1,000,000 for example or above $2m. This specialization is generally driven more by the particular market demographics. If there is enough transactional volume to make a good living you will begin to see specialization.

Due Diligence

Due diligence in residential is typically limited to less than 45 days in duration with the majority of this time eaten up by financing. Most buyers will have a physical inspection of a property completed by a professional inspector to ensure all systems are actually in working order. These inspections cover all aspects of the property and generally take two to four hours depending on the size and complexity of the property. Costing between $300 and $600 these reports are typically the first – and only – time most homebuyers will look ‘under the hood’ at their property. The due diligence period is also typically the only other time in the entire process where a buyer will revisit the property before closing. While in certain areas it may be recommended for buyers to perform specialized inspections, sewer scoping for instance, it is unusual to see much beyond the basic physical inspection. Most residential transactions will incur no more than $1,000 in total for any due diligence inspections.

The majority of this process is coordinated by the broker. Most will have a goto home inspection service and even know specialists for things like sewer should that be required. In some situations brokers and buyers will use inspections to come up with price reduction requests. Noting something found in an inspection a broker will request a price reduction or credit equal to the cost of repairing the noted item.

Commercial due diligence generally takes far longer than residential. The shortest is usually 60 days and it is not unheard of to see due diligence periods extend for more than six months. While there are complete commercial property inspectors, running in excess of $5,000 to evaluate a property, it is far more typical for a buyer to hire multiple specialists to evaluate specific items. Foundations for example would require a specialist to fully determine the current condition and give a buyer a detailed report on that one part of a property. It is not unusual to complete a dozen specific inspections during a due diligence period in commercial. From a survey to an environmental evaluation (Phase I) to determine any contamination. Each of these can cost thousands and take weeks to complete. Some, like a Phase II Environmental Inspection, even require drilling and taking core samples which adds an entire level of complexity to the negotiations. It is not unusual to see a commercial property buyer spend $25,000 in due diligence inspections and reviewing a potential purchase. Larger buyers and investors have entire on staff teams of people that just do pre purchase due diligence.

One very distinct difference in the Due Diligence period between Residential and Commercial is the extensive use of legal council in the commercial process. It is rare to see a buyer have a contract or additional docs reviewed by a lawyer, let alone have one at closing to ensure everything is accounted for. In Commercial, however, it would be a big red flag if a buyer did not have a lawyer involved from quite early all the way through the process.

Most Commercial buyers will have a goto lawyer they use for all legal issues related to their properties. Lease review, title review, contract review, contractor agreement review, survey review, etc. It is not unusual to see legal bills well into five figures just for buying a property.

While a broker may not be coordinating all of these inspectors and evaluations during the Due Diligence period they must track each one and fully understand the nuance of the results and how they will affect the deal.

In general in Residential transactions unless an inspection comes back with some big red flags there’s little further negotiation to be done and the deal will move to closing as soon as financing has completed.

Commercial can see the results of Due Diligence force a contract extension for either further inspection (Environmental Phase II) or remediation of various conditions (non functional sprinkler system) the seller would be obligated to repair regardless of the sale. These extensions can add months to a contract to complete everything.

The broker can in many cases be an invaluable shepherd in this process to guide the buyer and seller successfully through all the twists and turns to the closing.

Getting to Closing

With all the added complexity of Commercial transactions it is unusual to see any single broker working on more than three or four deals at once. Each one may look and feel completely different with differences in financing, contract terms and just about everything else. As I was told early in my career: “Everything in Commercial is Negotiable” and there are plenty of buyers and sellers that relish negotiating every little detail. You can literally be selling identical buildings and the contracts will look nothing like each other.

Conversely in Residential it is not unusual for a busy broker to close 40 houses in a year. Closing one a week or more. This is possible because so much has been streamlined and simplified already. From the ease of financing (thank you Fannie and Freddy) to the substantially shorter contract periods it becomes very possible to crank through a number of properties.

Interestingly in most states in the US both Commercial and Residential brokers are required to go through the same licensure training and testing. Seeing the dramatic difference in complexity this is a bit hard to understand but there it is. The day after I got my license my manager looked at me and said: “You can forget all that. Now we can teach you commercial.”

Wise Acreage

Short Advice on Real Estate and Life

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―Warren Buffett

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―Aristotle

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Lance Morrow

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