The five-unit threshold is a genuine dividing line in real estate finance. Above it, properties are valued on income rather than comparable sales, appraisals are commercial, and the metrics lenders use change.
These questions cover what shifts when you move up in unit count.
Quick answer
Properties with five or more units are financed as commercial multi-family. Valuation is based primarily on net operating income rather than comparable sales, appraisals are commercial, and lenders often use net operating income rather than gross rent in their coverage calculation.
Frequently Asked Questions
What changes at five units?
The property moves from residential to commercial financing. Appraisal methodology, valuation approach, underwriting metrics, and often the loan structure all differ.
How are apartment buildings valued?
Primarily on income, using net operating income and a market capitalization rate, rather than on comparable sales as with one-to-four unit properties.
What is a cap rate?
Net operating income divided by property value. It expresses the unleveraged return and is the primary valuation tool in commercial multi-family.
Does the coverage calculation change?
Frequently yes. Commercial lending typically uses net operating income after operating expenses rather than gross rent, which produces a different and usually lower ratio than residential DSCR.
What DSCR is required on commercial multi-family?
Requirements commonly run higher than residential, often 1.20 to 1.25 minimum, reflecting the different calculation basis and asset class.
What is net operating income?
Gross rental income less operating expenses — taxes, insurance, management, maintenance, utilities, and vacancy allowance — but before debt service.
Are terms different than residential loans?
Often. Commercial multi-family loans may carry shorter terms with balloon payments, different amortization schedules, and different prepayment structures.
What down payment is required?
Commonly 25 to 35 percent depending on the asset, market, and borrower. Leverage is generally tighter than one-to-four unit residential.
Do I need multi-family experience?
More often than on residential deals. Lenders on larger assets frequently want to see relevant operating experience or a qualified property manager in place.
What documentation is required?
Considerably more — trailing twelve months of operating statements, current rent roll, expense detail, and often property condition assessments.
What is a T-12?
Trailing twelve months of actual operating income and expenses. It is a core underwriting document on commercial multi-family and lenders scrutinize it closely.
How is vacancy treated?
Explicitly, unlike residential DSCR. Commercial underwriting applies a vacancy and collection loss allowance to gross income when calculating net operating income.
Are management fees deducted?
Yes, typically. Commercial underwriting deducts a market management fee even if you self-manage, since the property should support professional management.
What about capital expenditure reserves?
Commercial lenders often require ongoing replacement reserves for capital items, which is generally not the case on residential DSCR loans.
Is the process longer?
Typically yes. More documentation, more complex appraisal, and often property inspections extend the timeline compared to residential.
Can I use a DSCR-style loan on 5-10 units?
Some lenders offer hybrid products for small commercial multi-family that borrow residential simplicity. Availability varies considerably.
What is the advantage of moving to larger assets?
Economies of scale in management, income diversification across more units, and value that can be directly increased by improving operations rather than waiting for market appreciation.
What is the main risk?
Operational complexity and the fact that value is tied to income performance. Poor management directly reduces the asset's value, unlike a single-family where value tracks the market.
Should I move from fourplexes to apartments?
It depends on your capacity to operate at that scale. The financing is available; the operational demands are what most investors underestimate.
What should I evaluate first?
The trailing operating statements against the seller's pro forma. The gap between actual performance and projected performance is where most apartment deals go wrong.
