From the experienced real estate investor to the beginner real estate investor, many people find it difficult to choose between commercial vs residential real estate investing. Each option comes with its own advantages as well as drawbacks. Investors torn between the two options for investing in real estate need to consider their tolerance to risk, long-term goals, the time they are ready to commit to the project, and the amount of capital available.
Residential real estate refers to multi family homes, single family homes, duplexes, quadruplexes, and condos. On the other hand, commercial properties refer to retail, office, hotel, industrial, shopping centers, high-rise, and mid-rise buildings. Residential properties are usually leased to individuals and families, while commercial real estate is leased to businesses.
The commercial vs residential real estate dilemma can be solved by considering the benefits of each option:
Benefits of Investing in Commercial Real Estate
- Longer lease terms – Residential leases typically run for a period of 12 months. However, a commercial lease could run even up to 10 years. The advantages of a longer lease are lower turnover costs, lower vacancy rates, and a higher guarantee of reliable cash flow. However, long lease terms have their disadvantages. If the owner of a commercial property is not happy with a tenant, they might find it difficult to make them leave if the lease is still valid.
- Higher returns – In most cases, commercial real estate investing is a high-risk, high-return affair. Commercial real estate usually has better returns and cash flow compared to residential property. With more space, commercial property owners can have more tenants, thus making more money. Longer lease terms on investment properties also mean a positive cash flow.
- Triple net leases – A triple net lease means that the commercial property owner is exempt from paying any costs on the property. The lessee (the individual or company leasing the property) takes care of all the property expenses directly. This includes costs such as commercial landlord insurance, property taxes, and the cost of any repairs or maintenance. Big companies often go for a triple net lease in order to maintain the property in a way that befits their brand. By shifting property expenses to the tenant, investors and landlords can easily figure out how much rental income they will earn each month. However, the rent charged for this kind of lease is often much less than the rent charged for standard lease agreements.
- Easier to increase value – The market value of residential real estate property is established by looking at the average value of similar residential properties in the area. This is determined by factors such as how many bathrooms and bedrooms there are. On the other hand, the market value of commercial real estate is based on how much revenue the property generates. The higher the revenue generated, the higher the resale value. This means if you can increase your cash flow, you can increase the value of the investment property.
Benefits of Investing in Residential Real Estate
- Lower cost of entry – When choosing between commercial vs residential real estate, the average investor will find it easier to save up for a single family home or multi family home rather than for a commercial investment property. Besides being relatively affordable, residential property investing is easier to understand. Commercial deals, on the other hand, are more complex and require significantly more evaluation and research. In addition, buying commercial property exposes real estate investors to greater risks.
- A larger pool of buyers and renters – In the past few years, the performance of the retail sector in the U.S. has been dwindling. Besides facing enormous competition from large stores such as Walmart, retails stores have also been hit by mushrooming online retailers that can offer the same products at a lower cost. As a result, many commercial spaces have remained empty all over the country, thus pushing down rental prices. However, the story is different for residential properties. Since everyone needs a place to stay, the demand for rental properties is always high. While it could take up to six months or more to find a tenant for a commercial space, finding a renter for a home can take only 30 days or less. This is why investment in properties such as a single family home or multi family home would be the best option when it comes to commercial vs residential real estate.
- Better performance in an economic crisis – Retailers are often the first to bear the brunt of an economic crisis. Therefore, even though commercial property may have long leases, it does not assure landlords and real estate investors that their tenants will be in business for the entire duration. On the other hand, regardless of the state of the economy, people still need a home to go to. As a result, residential property owners don’t feel the pinch of economic downturns as much as commercial property owners.
Interested in a residential investment property? Start searching for one right now.
Still confused about what to settle for between commercial vs residential real estate? Here are a few more factors to consider:
Financing
The ability to secure investment property financing is a very important consideration in the commercial vs residential real estate debate. To qualify for a commercial loan, real estate investors must have a solid credit score and a well thought out business plan. Unlike residential lenders, commercial lenders are interested to know if the investment property will generate positive cash flow. Before approving the financing, they will want to know what kind of maintenance will be needed and who will pay the utilities. Due to the online retailer influx, most lenders are now reluctant to finance commercial properties meant for retail. As a result, securing a residential loan is much easier compared to a commercial loan.
Ease of Analysis
When it comes to investing in residential property, there are three ways of making money: appreciation, cash flow, and equity buildup through paying off a mortgage. Real estate investors can analyze residential properties using simple ratios such as capitalization (cap) rate, cash on cash return, and return on investment.
Investment in commercial real estate requires understanding and analyzing many more metrics. Besides valuation and acquisition ratios, investors also need to find details such as rental history, maintenance history, and property expenses which are usually not included in the listing. In addition, they need to analyze profit and loss statements for the past twelve months. All this can be a headache for the investor who is not in a commercial vs residential real estate career.
The Winner?
Considering all the factors above, the clear winner in the commercial vs residential real estate investing debate is residential real estate. Instead of putting all their money in one commercial property, investors can purchase several residential properties in different areas, thus diversifying their real estate investment and spreading the risk. In addition, it is easier to understand and analyze the different types of real estate investment for residential purposes.
To start looking for and analyzing the best residential investment properties in your city and neighborhood of choice, click here.