Residential Vs. Commercial Real Estate Investing:
If you are hoping to secure good returns in the long run, you might be debating between commercial vs. residential investment and which would be a better addition to your selection.
1. What is the Difference Between a Commercial and Residential Property?
The technical difference between a commercial and residential property is as follows:
- Residential real estate is all single-family houses and one to four-unit rental residences while commercial property is anything with at least five or more units. Apartments, Condos, duplexes, and quadruplexes make up residential real estate while hotel, office, retail, industrial, multifamily (of five units or more), and special purpose buildings are considered to be commercial real estate.
- Another difference between residential and commercial properties is the type of tenant each building accommodates. Residential properties are normally leased to individuals and families, while commercial properties are leased to different businesses.
- Residential real estate: is all single-family homes and one to four-unit rental residences. In contrast, commercial property is anything with five or more units. Condos, duplexes, and quadruplexes make up residential real estate, while office, retail, industrial, multifamily (of five units or more), hotel, and special purpose buildings are considered commercial real estate.
- Commercial properties : Commercial real estate tends to award investors a much wider range of potential investment. For example, there are more commercial property investment funds than residential ones. On the other hand, residential real estate investing tends to give investors a more active role in the property.
Finally, every property type comes with a different set of possibilities. Commercial real estate tends to grant investors a quite wider range of potential investments. For instance, there are more commercial property investment funds than residential ones. While residential real estate investing tends to give investors a more active role in the property.
2. Benefits of Commercial Real Estate Investing
- Higher Returns:
You’ve heard the saying,” with greater risk comes greater reward,” which is quite poignantly the case with commercial properties and higher returns. Compared to the returns on residential properties, commercial property cash flow and returns are far more attractive. According to the National Council of Real Estate Investment Fiduciaries (NCREIF), Property Index, commercial real estate investments have an annual average return of 12.7 percent compared to the S&P 500, with an average annual return of 8.8 percent over the past 15 years. More space equals more tenants, which equals more money in your pocket. Not bad for an investor looking to diversify their portfolio.
- Qualified Renters:
It can sometimes be difficult for investors looking to rent out their single-family property (or small multi-unit property) to find tenants who are qualified and who will keep the property up to snuff. On the other hand, commercial renters tend to be businesses, corporations, or something of the like. Because a larger company backs them, they are typically more likely to respect the property and its rules. While this is not always the case, qualified renters will make any property owner’s life easier.
- Triple Net Leases:
A triple net lease (triple–Net or NNN) is a lease agreement on a property whereby the tenant or lessee promises to pay all the expenses of the property including real estate taxes, building insurance, and maintenance. While triple net leases vary from case to case, they are extremely valuable for commercial real estate investors. With a triple net lease, the property owner does not have to pay any property expenses. The lessee handles all property expenses directly, including real estate taxes, so all the property owner has to pay is the mortgage.
- Longer Lease Terms:
Commercial leases tend to be much longer when compared to residential properties, which typically range from six to 12 months. It is not uncommon for commercial properties to lease for anywhere from five to 10 years. For investors, this means lower turnover costs and vacancy rates. The long lease terms signal reliable, positive cash flow for those worried about marketing a property from year to year. Commercial investors can end up with less than desirable tenants for extended periods of time. Still, with the right application process and legal protections, investors can avoid any long-term issues.
- Easier to Increase Value:
One of the biggest differences in residential and commercial real estate is how property values are determined. While residential real estate is largely influenced by comparable properties, commercial real estate is directly impacted by how much revenue it generates. Simply put, the amount of cash flow a commercial property is earning, the higher the property value will be. With the right tenants, investors could see an increase in value at a much faster rate than residential housing.
Smart investors know that it is of utmost importance to evaluate all the pros and cons before making a final investment decision. However, these benefits of commercial real estate investing are undeniable.
3. Benefits of Commercial Real Estate Investing
- Cost of Entry:
While it is possible to obtain commercial real estate loans even as a newbie investor, the cost of investing in residential real estate is most certainly less than commercial real estate at least to start. The average person may not have enough savings for a sizable down payment on a commercial property, while it is much more likely that they have enough saved for a single-family home. If the thought of a commercial property sounds too overwhelming for a new investor, think of it this way: Once an investor has purchased several cash flow producing residential properties, they will likely have the capital and necessary experience to invest in a commercial building.
- Decreased Renter Turnover:
For residential real estate investors, especially if their focus is on single-family homes, renter turnover is not something dealt with often. Businesses change and grow, and those are usually the tenants that make up commercial properties. With that kind of volatility, it can be difficult to keep tenants for long periods of time. In fact, if you market and screen tenants correctly as a residential real estate investor, you can find individuals who are committed to being long term renters. If you focus on acquiring only long-term tenants, you can be more confident that they will treat the home as if it’s their own.
- More Lenient Partitioning Laws:
With commercial investing comes far more red tape to deal with as the property owner. Partitioning laws are stricter, building permits are harder to come by, etc. With residential real estate, rules and regulations are more lenient and more small scale.
- Larger Buyer and Renter Pool:
Think about it: everyone needs a place to live, right? Residential real estate benefits from having a large pool of potential tenants and buyers compared to commercial real estate – which relies on businesses. As companies acclimate to online marketplaces and remote work opportunities, investors may find it harder to attract commercial tenants in some markets. The high demand for residential real estate makes this a particularly attractive opportunity for investors, no matter the market.
- Performs Better in Economic Crisis:
Businesses are often the first to experience the costs of an economic downturn, which can affect commercial investors in a few ways. First, commercial property owners hoping to attract tenants while the economy is in decline may find marketing the property to be particularly challenging. Residential real estate is by no means immune to these challenges; however, as a whole, residential property owner will benefit from the fact that housing is always in demand (despite the state of the economy). There is also no guarantee a company will stay in business for the duration of a commercial lease. This can present a unique challenge for commercial investors counting on long term residents.
4.Merits of Investing in Commercial Properties Compared to Residential Properties
1.Higher Income Potential
The most important advantage is that commercial properties have more income potential than residential properties. This is because your customers are usually business-owners or companies which have more money than families and individuals for residential properties.
On average, commercial properties have an ROI (return of investment) of 6%-12% depending on its location while single family home properties have an ROI of 1% to 4%.
- For renting agreements: the relationship between the renter and the landlord is usually informal.
- For leasing agreements: However, the lessor and the lessee have a more professional relationship with each other. In most cases, the relationship is even business-to-business if a company owns the property and is the one offering it to their clients.
Lastly, commercial real estate investments provide excellent value appreciation rates. There are many reasons why commercial properties tend to increase in value. The biggest contributor to this is new developments in high volume footfall traffic areas, which allows the commercial property owners to not only earn money from leasing contracts but also from reselling the property in the future.
3.Demerits of Commercial Property Investing
Investing in commercial properties also comes with its disadvantages. One main disadvantage is the large amount of work and time commitment that you need to put into it.
While having tenants on residential properties can be a passive income, for commercial properties, you will need to be more involved especially with the property’s maintenance.
- You also always have to be more aware of how your client is using your property and should maintain a constant communication with them.
- Acquiring a commercial property also requires more capital than acquiring a residential property which means it is much more difficult to start investing on it.
- Although it can give you a higher ROI than a residential property, for investors that have limited funds, this can be a real deterrent.
Investing in commercial properties also poses more risks. These properties are used by more people and thus, are also more susceptible to damage. These are also usually located in busier places which can also cause more damage from vehicles, vandalism, etc.
4. WHICH TO CHOOSE AND WHY?
There are a number of factors that can help you decide between a residential vs. commercial real estate investment. Check out a basic comparison between commercial and residential properties in the infographic below:
This shows that we can differ between commercial and residential investment on the basis of 8 major factors. Let’s talk about each of these below:
One of the key distinguishing factors between commercial and residential real estate is the type of properties you can invest in each category. Residential investment primarily focuses on houses, flats (including penthouses), and plots that are dedicated to the construction of a house. In contrast, commercial investment caters to shops, offices, as well as plots that can be used for the construction of an office building or a plaza.
Choosing between residential and commercial investment also depends on the purpose behind your venture. Are you planning on using the property for your own accommodation or business needs, or is it going to be a means of regular income? Do you simply want to hold on to the property for resale at a later date? Residential properties are generally used for self-accommodation or as a rental property for potential tenants, which allows you to earn monthly income from the home. Alternatively, you might also consider a long-term residential investment in a house or plot with the hopes of selling it for a greater profit in the coming years.
In contrast, commercial properties attract businessmen and business owners who require office premises for their staff or a shop to display their products for sale. Commercial investors might also be interested in purchasing an empty plot of land and converting it into a warehouse or an office building, where different offices can be offered for rent or for sale to various organizations.
There are a number of factors that can increase the worth of your property, including its location, the neighborhood it’s in, the amenities nearby, and so on. Thus, while residential properties are available in varying sizes, the cost can differ from city to city and project to project. Commercial properties, however, are impacted by a different set of variables. A road front location of a shop and an easily accessible office building are two of these. But what’s important to note here is that investing in commercial property is not only expensive overall, but there’s also a restriction on sizes of commercial plots and shops, with a smaller range available.
Residential property owners usually have a lot more freedom in terms of design, structure, construction bylaws, and rental agreements. It is also easier to build a residential home with fewer zoning and planning permissions needed. On the other hand, if you decide to buy a commercial property, the laws and regulations become stricter, and you’ll need to cross several hurdles to get the respective permissions to build and design as per your preference.
When you debate between a commercial vs. residential investment, you’ll also need to think about which one works best for you in case of an economic crisis. The fact remains that the demand for housing rarely falters, with almost everyone needing a roof over their heads, with whatever savings they have and whatever rent they can afford. However, the moment the economy takes a dip, many companies, stores, and organizations might consider reevaluating their expenses, their premises, their overheads, and so on.
Let’s now consider the pool of investors/renters you have at your disposal. The demand for housing never really ends, so there will usually be a constant demand for properties and a large pool of buyers willing to rent/buy your house if you choose to rent/sell it. But on the other end of the spectrum, commercial establishments are only in demand by firms, organizations, and retailers, all of whom will not be looking in the market for a second option if they already have a well-established setup.
This is one aspect where commercial investments take the lead. You’ll generally earn a lot more in terms of renting and reselling a commercial property in comparison to a residential home. While this type of investment has greater risks, it has greater rewards as well. This is particularly because it is easier to increase the value of commercial real estate over time. If you have a successful shop that generates revenue, selling it to the next owner is going to be a lot easier than adding an extra room to a residential property to boost its price.
When it comes to maintaining your real estate investment, residential properties are lighter on the pocket, primarily because your tax bracket changes as soon as you declare yourself as the owner of a commercial property. Thus, not only will you be paying more taxes, but you’ll also be paying higher utility bills, as is the norm with all commercial establishments because their overheads are generally costlier.
Choosing between a commercial real estate vs. residential investment property is no easy feat to tackle, especially because both come with their own set of benefits and drawbacks. Both will diversify your portfolio, both come with significant tax benefits, and both will bring you one step closer to achieving your financial freedom…So how is an investor to choose? The answer to that question ultimately depends on what they want to gain by investing in real estate. Investors should take some time to think about their short and long-term goals. If they are looking to make a quick buck to start, rehabbing or wholesaling a residential property might be the way to go. On the other hand, if they are in it for the long haul and looking to achieve passive income, commercial properties offer attractive benefits. If you want to earn the most returns, you might want to consider investing in commercial real estate. On the other hand, residential properties may be more appealing if you’re more comfortable working on a small scale. Thinking about how much time you’re willing to devote to your project and your risk tolerance can make it easier to decide where to invest your money.