Choosing between commercial vs residential real estate investing isn’t something you can do overnight. Both come with their own strategies, which provide their own set of benefits and challenges.
An investor’s path depends on risk tolerance, goals, time, and liquid capital. To this end, this Commercial vs Residential real estate investing article aims to delve deeper into each type of real estate investing so you can make an informed decision.
Commercial vs Residential Real Estate Investing: How Do They Differ?
To understand how both investing methods differ, we must highlight the practical difference between commercial and residential property. Commercial property deals with any building with 5 or more units, while residential property is the term given to single-family units and rental residences with 1 to 4 units.
Office, industrial, retail, multi-family, specialty buildings, and hotels are deemed commercial real estate, while quadruplexes, duplexes, and condoms are residential real estate.
A major difference between residential and commercial properties is the kind of tenants placed in each building. Commercial properties are leased to businesses, while residential units are leased to individuals and families.
Furthermore, each property tends to come with its own opportunities. Residential real estate investing gives investors an active role in property management, while commercial real estate offers investors a wider array of prospective investments. For instance, there are a lot more commercial real estate investment funds than those catering to residential investment.
Benefits of Residential Real Estate
Residential Properties Perform Better in Poor Economic Situations
Businesses generally experience economic downturns first, which can influence commercial real estate investment in a couple of ways.
First off, commercial real estate owners looking to attract new tenants during an economic decline can find marketing their property quite challenging. And while residential real estate isn’t immune to an economic downturn, residential real estate owners are more inclined to profit from the fact that people will always need housing irrespective of the economy’s state.
Furthermore, there isn’t any guarantee that a business will remain in operation throughout its commercial lease. This presents a challenge for commercial real estate investors searching for long-term tenants.
Increased Renter and Buyer Pool
Shelter is one of the most basic needs that everyone on the planet has. This means there is a larger renter and buyer pool for residential real estate investors to select from compared to commercial real estate.
With the business landscape shifting to remote work opportunities and online marketplaces, commercial real estate investors find it challenging to attract more commercial tenants. The great demand for residential properties makes this investment opportunity an especially attractive one, regardless of market conditions.
Lenient Zoning Laws
Residential real estate comes with lenient regulations and rules that make investing easier. On the other hand, commercial investing comes with a lot more red tape for the property owners to handle. Commercial properties have strict zoning laws, and building permits are a lot harder to come by.
Lower Rate of Tenant Turnover
Residential real estate investors typically don’t have to worry about tenant turnover, especially concentrating on single-family units. However, businesses change, grow or go bust, and since businesses are tenants in commercial properties, certain volatility is involved in retaining tenants for a long time.
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This volatility means a lot more work is involved in regularly finding tenants. In fact, residential real estate investors will discover that marketing and screening tenants properly can result in finding tenants bound to be long-term renters. Concentrating solely on long-term tenants can be an intelligent move for residential real estate investors.
Price of Entry
While a new real estate investor can obtain commercial real estate loans, the cost of investment in residential real estate is typically lower. Generally, the average person might not have substantial money to make a sizeable down payment on a typical commercial property; however, they will more likely have enough saved to purchase a single-family unit.
The entire commercial real estate investing process can sound confusing; however, it shouldn’t. Once a real estate investor purchases various cash flow-generating residential units, they will no doubt have the capital plus the required experience to engage in commercial real estate investing.
Benefits of Commercial Real Estate
Intelligent investors understand the need to evaluate the advantages and disadvantages of an investment opportunity before making a final decision. Nevertheless, the benefits associated with commercial real estate investing are considerable.
Higher Value
One significant difference between commercial vs residential real estate investing is how the property values are determined. For residential properties, comparable properties in the vicinity typically influence how valuable the property is; however, with commercial real estate, its value is correlated to its earning potential.
When commercial real estate has the right tenants, the property owner could see an increase in the value of their property much faster than what’s obtainable with residential real estate.
Longer Lease Terms
Commercial real estate leases tend to be much longer than residential real estate. Most commercial leases naturally range from 5 to 10 years compared to residential leases that last from 6 to 12 months.
Longer lease terms mean lower vacancy rates and turnover costs for commercial real estate investors. The longer lease terms offer a positive and reliable cash flow, limiting the need to market a property from one year to the next.
Unfortunately, the longer lease terms can also mean that commercial real estate investors have to deal with less-than-perfect tenants for longer periods. Nevertheless, commercial real estate investors can avoid any long-term problems with appropriate legal protections and application processes.
Triple Net Leases
While the valuation of trip net leases can vary depending on the case, they can be particularly valuable to commercial real estate investors. With a triple-net lease, the property owner is not responsible for any property expenses. All of the property expenses are handled directly by the lessee; this includes expenses such as real estate taxes. The property manager has to pay the mortgage on the property.
Large organizations generally prefer this type of lease to ensure the property remains in line with their brand design. They manage these costs while the property owner doesn’t pay maintenance costs. While commercial real estate investors can choose different types of net leases, a triple net lease is a unique benefit of owning commercial real estate.
Qualified Tenants
It can be quite arduous for investors trying to fill the vacancy in their small multi-unit property or single-family property using qualified tenants. This isn’t the case with commercial tenants as they tend to be corporations or businesses.
Since these tenants are typically backed by a larger organization, they tend to respect the property and its associated rules. Qualified tenants can make the process of owning a commercial property easier.
Higher Returns
There is a correlation between the amount of risk associated with an investment opportunity and the reward it yields. This is especially true for commercial real estate investment opportunities.
Compared to residential properties, the returns you get from commercial real estate investing are higher. According to statistics, commercial real estate investments have a significantly larger average return (12.7%) compared to the S&P 500 index (8.8%) over the last 15 years.
A commercial real estate investment opportunity means more space which means more tenants. More tenants correlate to more rental income, which is always attractive for a real estate investor.
Commercial vs Residential Real Estate: Which One Is Best?
Deciding between commercial vs residential real estate investing isn’t as easy as one might think. This is because they have their unique advantages and disadvantages. Both property investment opportunities are bound to diversify your investment portfolio, come with large tax benefits, and can help you achieve your goal of financial freedom.
The real estate investment opportunity you choose in the commercial vs residential real estate investing debate depends on what you aim to gain from investing. Prospective investors should consider their short term and long-term aims.
For example, wholesaling or rehabbing residential properties could be the best solution if you are interested in making “quick” money. Conversely, if you prefer to invest for a long time to generate passive income, then commercial real estate investing is the choice for you.
Conclusion
Generally, there are various factors to consider when deciding between a commercial vs a residential real estate investment. If you want to work on a small scale, then residential real estate investing is your choice.
Alternatively, commercial real estate investing might be your choice if you want to generate the most returns. A way to decide is to consider how much time you intend to dedicate to the real estate project.
You also have to consider your level of risk when investing. You should also note that just because you choose one option in the commercial vs residential real estate investing opportunity doesn’t mean you can select the other later on.
