You own three duplexes and a triplex. You find a building two streets over with five units, priced about where you would expect, rents about where you would expect, and a seller who wants to close in thirty days. You call the same broker who did your last four loans and ask for the same product.
And the answer changes. Not the rate. The product. The appraisal form, the down payment, the amortization, the term, the reserve requirement, the prepayment structure and the number the lender divides by. All of it moves, because somewhere between the fourth unit and the fifth, residential real estate finance ends and commercial real estate finance begins.
Nothing about the building changed. The brick is the same brick. What changed is the entire regulatory and secondary-market apparatus that sits behind the money, and it draws its line at four.
Where the line comes from
The four-unit boundary is not a lender preference. It is inherited from the definition of residential property used throughout the mortgage system. One to four units is residential. Five or more is commercial, full stop, regardless of how the building looks, who lives in it or what the zoning calls it.
That definition drives everything downstream. Residential appraisal forms exist for one to four units and stop there. Residential underwriting conventions, residential loan programs and residential secondary-market execution all stop there too. The investor loan products most of us use day to day, including the DSCR rental loan, were built on top of that residential infrastructure, which is why they stop at four as well.
This also means the count is the thing that matters, not the shape. Five units in one building is commercial. A duplex and a triplex on one parcel adds to five and is commercial, which is the complication underneath financing multiple dwellings on a single deed. A house with four legal apartments and a basement unit that nobody permitted may be a four-unit building on paper and a five-unit building in reality, which is the fight described in when the zoning does not match the property.
The appraisal is a different document
On a two to four unit purchase the appraiser completes a small residential income form and a rent schedule, as described in why your triplex does not get a 1004. Value is driven primarily by sales comparison, with the income approach as support.
At five units you leave the forms entirely. You get a narrative commercial appraisal, commonly thirty to eighty pages, and the hierarchy inverts. The income approach leads and the sales comparison supports it. The appraiser builds a stabilized net operating income, selects a capitalization rate from the local market, and divides.
Three practical consequences. It costs more, commonly two thousand to five thousand dollars rather than six hundred to nine hundred. It takes longer, commonly three to five weeks rather than one to two. And it is far more sensitive to your operating statement than to the three houses that sold nearby, which means the adjustment grid that drives a residential value is no longer the thing you are arguing about. You are arguing about expenses and a cap rate.
The appraiser is also more likely to raise a highest and best use question on a commercial assignment, because the analysis is formally part of the report.
The ratio is computed from a different number
This is the single most important shift and the one that costs people money.
A residential DSCR loan typically divides gross rent by the full housing payment. Rent over principal, interest, taxes and insurance. Operating expenses mostly do not appear, because the convention assumes them.
A commercial loan divides net operating income by annual debt service. The numerator is rent after vacancy and after operating expenses. The denominator is principal and interest only, because taxes and insurance already came out of the numerator as expenses. Two different formulas producing two different numbers from the same building, and if you carry the residential habit across the line, you will overestimate your coverage badly.
Run it. A five unit building grosses 5,500 dollars a month, or 66,000 dollars a year. Apply five percent vacancy and effective gross income is 62,700 dollars. Apply thirty five percent operating expenses, which is a normal figure for a small apartment building where the owner pays water, trash, common electric, insurance, taxes, management and maintenance, and operating expenses are 21,945 dollars. Net operating income is 40,755 dollars.
Finance it at 350,000 dollars, seventy percent of a 500,000 dollar price, at 8.25 percent on a twenty five year amortization. Principal and interest are about 2,760 dollars a month, or 33,120 dollars a year. The commercial DSCR is 40,755 divided by 33,120, or about 1.23.
Now compute the same building the residential way: 5,500 dollars of gross rent against principal, interest, taxes and insurance of about 3,510 dollars. That is 1.57. The building did not get better. You just used the formula that flatters it. If you are not yet fluent in moving between these, read how to build the NOI a lender will actually use and cap rate versus DSCR before you write the offer. The residential version of the math is in how to calculate DSCR, and the DSCR deal calculator will do the residential side for you.
What the terms look like on the other side
Expect a different structure, not just a different rate. Down payment commonly moves from twenty to twenty five percent up to twenty five to thirty five percent. Amortization commonly shortens from thirty years to twenty or twenty five, which raises the payment even when the rate is similar.
The term and the amortization stop matching. A commercial loan is frequently a five, seven or ten year term amortized over twenty five, with a balloon at the end. You are not financing this building for thirty years. You are financing it until the balloon, and you will refinance or sell into whatever market exists on that date.
Reserves get larger, often six to twelve months of debt service rather than three to six. Recourse is more negotiable and more variable; many small-balance commercial loans are full recourse, some are non-recourse with carve-outs. Prepayment is structured differently, with step-downs, yield maintenance or occasionally defeasance in place of the simpler penalties on the residential side. And many lenders will escrow for replacement reserves, a line item that does not exist on a residential rental loan.
A four unit purchase under the residential convention, say 420,000 dollars at seventy five percent, is a 315,000 dollar loan at 7.5 percent over thirty years, about 2,203 dollars of principal and interest, plus 450 dollars of taxes and 300 dollars of insurance, for 2,953 dollars against 4,400 dollars of rent. That is a 1.49 ratio on a product you can close in three weeks. The five unit next door is a different deal with different money behind it, and the per-unit price being lower does not by itself make it a better buy.
The documents the lender will ask for
Commercial underwriting looks at the business, not just at you. Expect requests for two to three years of operating statements on the property, a certified rent roll with lease start and end dates, copies of every lease, trailing twelve month income and expense detail, and your own schedule of real estate owned.
Expect a property condition assessment on larger or older buildings, and on some properties a Phase I environmental report. Expect questions about management, because a lender financing a five unit building wants to know whether an experienced manager is involved. And expect the entity to matter more; commercial lenders generally want a single purpose entity holding this asset and nothing else.
The timeline follows from the document list. Forty five to sixty days is normal. Thirty is aggressive. If your contract says twenty one days because that is what your last duplex took, you are going to need an extension, and the municipal items that can independently stall a recording, including a point-of-sale sewer certification, do not pause while you wait.
When to stay at four on purpose
There is a real strategy in staying under the line. Four units is the largest building that still gets residential execution: longer amortization, lower down payment, cheaper and faster appraisal, simpler documents and a product that is easy to repeat. Two to four unit financing is the most efficient money available to a small investor, and a lot of durable portfolios are built entirely inside it.
If you want scale without crossing over, the usual answer is more buildings rather than bigger ones, and at some point a portfolio loan across several rentals rather than one commercial loan on one building. Different structure, different covenants, but it keeps the collateral residential.
Stay at four deliberately, though, not accidentally. Buying a five unit building and planning to convert it to four is a construction project with a permit risk attached, and lenders underwrite what exists on the day of the appraisal.
What does not change
Crossing into commercial does not exempt you from any of the local or tenant-side obligations. A nuisance designation hits a five unit building exactly the way it hits a duplex, and the consequences described in how a city counts points against your address apply with more units generating more calls. Shared tenancies and the liability clause analyzed in joint and several liability on a lease appear more often in larger buildings, not less.
What does change is how much a single mistake costs. A vacant unit in a duplex is half your income. A vacant unit in a five unit building is a fifth of it, which is better, but a 350,000 dollar loan with a balloon in seven years punishes a bad operating year in a way a fully amortizing thirty year loan does not.
We place loans on rentals and flips across Pennsylvania and additional states, and the five unit conversation is one we have several times a month, usually with someone who has four duplexes and a contract they signed assuming nothing would change. If you are looking at a building with five or more doors, send us the rent roll and the expenses before you lock a closing date. The number we need to see first is net operating income, not gross rent.
FMC Capital is a Pittsburgh-based mortgage brokerage serving real estate investors. NMLS #1840537. Call 412-990-2941. Loan terms, pricing and program guidelines vary by lender and by property and are subject to change. This article is general information and not legal, tax or financial advice.