Commercial real estate is land and buildings held to earn income or to house a business: offices, shops, warehouses, hotels, apartment buildings of five or more units and land held for development. The investment industry sorts it into asset classes by the kind of tenant a building serves. The main asset classes of commercial real estate run from office and retail to industrial, multifamily, hospitality, land and special purpose.
The use decides the label, whatever the state of the space. A bare shell space offered to a business counts, and so does an office suite fitted out with a landlord's tenant improvement allowance. The commercial real estate glossary defines the terms that come with each class.
| Property | Counted as commercial real estate? | Where the answer can change |
|---|---|---|
| Office building | Yes | An owner who runs a business from it still owns commercial property |
| Shop, restaurant or shopping centre | Yes | A shop under apartments can change the class of the whole building |
| Warehouse, factory or flex building | Yes, as industrial | Zoning maps it in an industrial or employment district |
| Apartment building of five or more units | Yes, as multifamily | The IRS can still call it residential rental property |
| House, duplex, triplex or fourplex | Usually residential | A business use in a one-unit home leaves it residential for Fannie Mae |
| Hotel or motel | Yes, as hospitality | The IRS counts transient rooms as nonresidential |
| Land held for development | Yes | Land itself never wears out, so it is never depreciated |
| School, church or hospital | Rarely traded | The EIA counts these as commercial buildings |
Apartment buildings cross into commercial real estate at five units. Fannie Mae buys mortgages on residential properties "when the dwelling consists of one to four units" (Fannie Mae Selling Guide B2-3-01). CMHC's MLI Select program for rental projects starts at "a minimum of 5 units" (CMHC, MLI Select). The pillar guide explains why a fifth unit changes the loan.
Each lender, tax authority, zoning office and statistics agency writes its own test for commercial property, so the same building can pass one test and fail the next. The tests ask different questions. A lender counts homes, a tax authority follows the rent or the floor space, a zoning code reads the map, and a statistics agency measures how the floors are used.
| Who is asking | What the test measures | Where the line sits |
|---|---|---|
| Fannie Mae, US home mortgages | Dwelling units | One to four units are residential |
| CMHC MLI Select, Canadian rental insurance | Units and non-residential space | Five units or more; non-residential space up to 30% of floor area |
| IRS, US depreciation | Where the gross rent comes from | 80% or more from dwelling units is residential rental property |
| CRA, Canadian capital cost allowance | How the floor space is used | 90% in non-residential use earns the extra 2% allowance |
| Seattle and Toronto zoning | What the zoning map permits on the lot | Commercial, industrial, employment or mixed-use districts |
| EIA, US energy statistics | How the floorspace is used | Half or more in a use that is neither residential, industrial nor agricultural |
Lenders count units first. Fannie Mae's residential programme covers one to four units. It also buys mortgages on homes that "have a business use in addition to their residential use", such as a day care, a barber shop or a doctor's office (Fannie Mae Selling Guide B2-3-04). That policy needs a one-unit dwelling that the borrower occupies as a principal residence, with the borrower as owner and operator of the business.
In Canada, CMHC's MLI Select starts at five units and caps the commercial part of a rental project. Its rule reads: "Non-residential space must not exceed 30% of the gross floor area or 30% of total lending value" (CMHC, MLI Select). Above that cap, the project falls outside the program.
The IRS follows the rent. A building is residential rental property "if 80% or more of its gross rental income for the tax year is from dwelling units" (IRS Publication 946). Publication 946 names "an office building, store, or warehouse" as examples of nonresidential real property. Two details move buildings across the line:
- A hotel or motel room is no dwelling unit when more than half the units are used on a transient basis.
- An owner who lives in part of the building adds the fair rental value of that part to its gross rental income.
The CRA follows the floor space. Most buildings bought after 1987 go into Class 1 at a 4% rate. An eligible non-residential building can take an extra 2%, for a total rate of 6% (CRA, classes of depreciable property). To claim it, the owner must elect to put the building in a separate class. The CRA measures use by square footage, and the extra allowance needs at least 90% of the building in non-residential use at the end of the tax year.
Zoning sorts land by permitted use, and "commercial" is only one of its districts. Seattle's code lists districts "such as neighborhood residential, commercial, industrial, and downtown zoning" (City of Seattle, zoning). Toronto assigns each property a category "for example: residential, commercial, mixed use, employment, or institutional" (City of Toronto, Zoning By-law 569-2013). A warehouse usually sits in an industrial district in Seattle and in an employment zone in Toronto.
The US Energy Information Administration (EIA) counts a building as commercial when "at least half of the floorspace is used for a purpose that is not residential, industrial, or agricultural" (EIA, CBECS). Its survey therefore includes "schools, hospitals, correctional institutions, and buildings used for religious worship" beside stores, restaurants, warehouses and offices. In 2018, its latest completed survey, the EIA estimated 5.9 million commercial buildings in the United States. A factory falls outside that count, because its floorspace serves an industrial purpose.
A mixed-use building takes a different class under each test, because the IRS follows the rent while lenders and the EIA follow units and floor space. A shop under apartments shows how far the answers can drift apart.
Take a three-storey building with one shop on the ground floor and four apartments on the two floors above. Each apartment rents for $1,700 a month and the shop for $2,000. The building cost $1,200,000, without its land. The IRS sets the line at 80% of gross rent from dwelling units (IRS Publication 946). Its tables recover residential rental property over 27.5 years and nonresidential real property over 39 years.
Source: Sphera Credit calculation: a $1,200,000 building basis divided by the recovery period, 27.5 years for residential rental property (80% or more of gross rent from dwelling units) and 39 years for nonresidential real property, from IRS Publication 946.
The apartments bring in $6,800 of the building's $8,800 a month, or 77% of its rent. That share falls short of 80%, so the whole building is nonresidential real property. A full year's straight-line deduction comes to $30,769 ($1,200,000 / 39), where the residential schedule would give $43,636 ($1,200,000 / 27.5). The shop's rent sets the class: at $1,700 a month, the apartments would earn exactly 80% of the rent and the building would move to the 27.5-year schedule.
The other tests reach their own answers for the same building:
| Who is asking | Answer for the example building |
|---|---|
| IRS | Nonresidential real property: the apartments earn 77% of the rent |
| CRA, if the building stood in Canada | Class 1 at 4%: the shop fills one floor in three, far below 90% |
| Fannie Mae | Outside its mixed-use policy, which covers one-unit homes |
| CMHC MLI Select | Outside: four units, and a shop on a third of the floor area |
| EIA | A residential building: homes fill two of its three floors |
A tax professional should confirm any classification before you rely on it. The owner's own use, a short-term rental and the date the building went into service can each change the result.
People most often misplace the apartment line, assume a home business makes a house commercial, and treat industrial property as something apart from commercial real estate. Each mistake comes from reading one test as if it were the only one.
A five-unit building already counts. Some guides describe commercial multifamily as buildings with "more than five units", which leaves the five-unit building nowhere. Fannie Mae's residential rules stop at four units, and CMHC's MLI Select starts at five, so the first commercial size is five units.
A home business usually leaves a house residential. Fannie Mae accepts a day care, a barber shop or a doctor's office in a one-unit home. Its rule adds that "the property must be primarily residential in nature" (Fannie Mae Selling Guide B2-3-04). A buyer who wants a shopfront with a flat upstairs, or a building with several homes over a shop, moves into commercial lending, which the lending guide covers.
Investors, brokers and lenders count warehouses, distribution centres and factories as the industrial class of commercial real estate. Zoning and federal statistics draw the line elsewhere. Seattle maps industrial districts separately from commercial ones, Toronto calls them employment zones, and the EIA leaves industrial buildings out of its commercial count. A buyer who reads "commercial" on a zoning map should check whether a warehouse use is permitted there.