Commercial Real Estate vs Residential Property: Which is the Best Investment?

Estimated read time 6 min read

You may have wondered if residential or commercial real estate was a better investment, whether you are new to investing in real estate or have been doing so for some time. Truthfully, neither is better than another. Both have their pros and cons. Investors need to weigh these factors to decide which type of investment is best for them.

To help you decide on your investment strategy, let’s compare commercial and residential real estate.

Commercial Real Estate Investment

Commercial real estate includes any property with five or more apartments. Multifamily, office buildings, retail stores, industrial and hotel properties are typical commercial real estate. These properties are leased by businesses, not individuals or families.

Commercial real estate investment has many advantages

  • Triple Net Leases: The tenant is responsible for paying real estate taxes, maintenance and insurance in addition to the rent. Triple net leases, which are commonly used in commercial leases, are advantageous to investors as they reduce building costs and maintenance expenses that landlords typically cover.
  • Lengthier lease terms: Leases for commercial properties are usually longer, lasting anywhere between three and five years. They can even go up to ten years. It means fewer tenants will move and a longer-term rental income.
  • Consistent income: Because commercial real estate tenants are locked in for longer leases the cash flow for investors is higher and more consistent.
  • Potential for appreciation Unlike residential property, the value of commercial property is affected by its revenue. This means that investors may see a rapid increase in their property.

Commercial real estate: challenges and risks

  • High initial investment Commercial property is more expensive for investors due to its higher initial investment.
  • Strict Zoning Laws: Commercial property is subject to stricter zoning laws, which dictates how the properties should be arranged, including parking requirements and what types of businesses are allowed to lease space within the building.
  • More volatile During an economic recession, businesses are more vulnerable to struggling. This can leave investors with commercial properties without tenants. Commercial real estate can be a more risky investment because of this.

Residential Real Estate Investment

Residential real estate includes single-family houses or buildings with four or less units. Residential real estate includes condos, duplexes and triplexes. These buildings are sold to or rented by individuals and families for use as residences.

Investing in residential real estate has many advantages

  • Lower investment: Residential properties are cheaper than commercial ones, so investors can save more money for a downpayment on a duplex or single-family house.
  • A larger pool of buyers and tenants: Because housing is a necessity, residential real estate attracts a greater number of buyers or renters. Tenants in commercial buildings have more specific requirements for their space whereas individuals and families look for similar features when buying a house.
  • Less volatile The residential real estate sector is less volatile when it comes downturns in the market. Housing will always be in high demand. Businesses, however, feel the effects more acutely.
  • Simplicity of financing: In comparison to commercial real-estate, residential financing is much simpler and easier to analyze for investors. Residential loans are typically easier to qualify for and have longer terms and lower rates than commercial loans.

Residential real estate: challenges and risks

  • Less stable tenant: Although this isn’t always the case in residential real estate, the shorter leases tend to make for less-stable tenants. Businesses can stay in a commercial location for up to 10 years, but individuals and families are more likely to move around when renting.
  • Greater responsibility: Investors in residential real estate have fewer options to raise capital than those investing in commercial real estate. This means that investors are often required to pay the entire deposit by themselves. strong>More responsibility:/strong> Investors in residential real estate have fewer options to raise capital than those investing in commercial real estate, so they are often required to pay the entire ‘down-payment’ themselves.

What to consider when choosing which investment to make?

Investment goals and tolerance for risk

Due to the large amount of money needed to make a downpayment, commercial real estate is a more risky investment. However, greater risk can lead to greater returns. Commercial properties are more likely to increase in value and produce a higher cash flow than residential properties. Commercial properties have higher operating costs and are more difficult to sell.

Investors must determine whether they are able to handle the risk and decide if it is worth the higher return.

Capital and Financing Options

Commercial real estate may require a larger investment but there are many options to finance it, including partnering with investors, borrowing money from private sources, or joining a real-estate investment trust (REIT). Commercial real estate may be more accessible with these options, as residential investors can only partner with family members on these investments.

Commercial real estate loans, on the other hand tend to have higher interest rates, shorter terms and are more difficult to obtain because they are considered to be a riskier investment. Investors are required to submit a business plan detailing how they will pay for things, the projected maintenance and cash flow of their property. These requirements could encourage investors to concentrate on residential property instead of commercial.

Location and market conditions

It is important that you research the market conditions and property location. The location and market will have a significant impact on rents and prices. Costs may also influence your decision to invest in commercial property or residential.

Commercial real estate in your area may be suffering if businesses are closing or leaving office buildings. If there are many vacant single-family houses and residential properties, this could indicate that the market has enough housing options.

Management and involvement levels

Investors should consider that commercial and residential real estate require different levels management. Commercial properties are usually larger and require more maintenance. Investors will hire a property manager for this. Investors can manage residential properties themselves, as they are less complicated.

Long-term exit strategies and plans

Commercial property, in general, is a long-term investment (5 years or longer) because it requires more capital and can be difficult to sell. Residential real estate is a good option if you don’t want to be tied down for a long time. The pool of buyers is much larger.

Final Thoughts

You should choose a real estate investment that fits your budget, time commitment and returns.

Investors will start by investing in residential properties, which are cheaper, before moving on to commercial properties, which have a higher cash flow. They also tend to find tenants who are more reliable. Residential investments yield higher returns than commercial ones, so you can start with residential property and move on to commercial properties as your next step.

Do your research before making a decision. Research your market, your financing options and the types of properties that are available.

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