Real estate is by far the best investment and the leading strategy to get rich, given that it’s made about 90% of the world’s millionaires. However, not all real estate is created equal. Deciding on commercial real estate vs residential real estate can be difficult.
Both types of properties have their own unique benefits and drawbacks. In this blog post, we’ll discuss the differences between commercial and residential real estate so that you can make an informed decision about which type of property is right for you.
Table of Contents
What Is Residential Real Estate Investing?
Residential real estate investing is the process of buying, selling, and managing properties that are used as residences. Residential real estate includes any property with 1 to 4 units and can include:
- Single-family homes
- Multi-family homes
- Apartment buildings
- Mobile homes
The primary purpose of residential real estate is to provide a place for people to live. Because of this, it’s usually located in areas with good schools, jobs, and other amenities that make it attractive to potential tenants or buyers.
What Is Commercial Real Estate Investing?
Commercial real estate investing is the process of buying, selling, and managing properties that are used for business purposes. These can include:
- Office buildings
- Retail stores
- Manufacturing plants
- Hotels and motels
- Storage units
The primary purpose of commercial real estate is to provide a space for businesses to operate. Because of this, it’s usually located in areas with high foot traffic or near major highways.
What to Know About Investing in Commercial Real Estate
To make an informed decision about which investment option is best for you when comparing commercial real estate vs. residential real estate, you need to understand the benefits of each. Let’s look at a short commercial real estate guide on some of the things that set commercial real estate apart.
Commercial real estate typically has a higher rate of return than residential real estate. This is because commercial properties are usually leased to businesses willing to pay more for the space. After all, it helps them make more money.
For example, a business owner may be willing to pay $2000 per month for an office space located in a busy area. On the other hand, a family may only be willing to pay $1200 per month for a home in the same area.
This higher rate of return can help you make more money in the long run, which is one of the main reasons people invest in commercial real estate.
Easier to Increase Value
Another significant advantage commercial property has over residential is that it’s easier to increase the value and thus the rental rate.
While a typical home might appreciate an average of four percent per year, well-maintained commercial property can see appreciation at twice that amount.
Technically, commercial real estate is impacted by revenue and not comparable properties like residential properties. The more cash flow the commercial property generates, the higher the value.
The better the tenants you have, the more money you make, and the higher the value of your commercial real estate investment.
When it comes to commercial real estate, the tenants are usually larger and more qualified than residential renters. These tenants have generally been in business for a longer time, have good credit scores, and tend to stay in their leases for extended periods.
Additionally, because commercial spaces are often leased by businesses that generate income, the tenants are less likely to default on their rent payments. This provides a sense of security for the commercial real estate investor.
Commercial tenants also have their reputation to uphold, so they’ll protect your property to maintain a great image.
Triple Net Leases
Another significant aspect of commercial real estate is the triple net lease, in which the tenant agrees to pay all property-related expenses, including property taxes, insurance, and common area maintenance (CAM) fees. This means that as a commercial landlord, you’ll have fewer expenses to worry about and a more predictable monthly cash flow.
As an investor, you can also pass these expenses on to the tenant through a triple net lease agreement. It’ll give you peace of mind knowing that your property is being well taken care of.
Longer Lease Terms
The typical residential lease is for one year, with some leases lasting two years.
On the other hand, leases for commercial real estate can last anywhere from three to ten years or even longer. This provides commercial real estate investors with stability and predictability that’s not always possible with residential properties.
What’s more, commercial leases often have built-in renewal options. These allow tenants to extend their lease for an additional term, giving investors an even greater degree of stability.
What to Know About Investing in Residential Real Estate
While commercial real estate has some great benefits, there are also several advantages to investing in residential property. Here is the residential real estate guide on some of the things that set residential real estate apart.
Lower Upfront Costs
The upfront costs of commercial real estate are often much higher than residential properties.
In addition to the purchase price, commercial investors also need to factor in the cost of repairs and renovations (which can be significant). These costs can add up quickly, making it more difficult for new commercial investors to get started.
Residential real estate typically has lower upfront costs, making it a more accessible investment for new investors. Additionally, many residential properties can be purchased with a mortgage.
Even better, if you find a property that has been on the market for a while, you may be able to get it for an even lower price. You can discover more here about how to know how long a property has been on the market.
More Lenient Zoning Laws
Commercial real estate zoning laws are often much more restrictive than residential property, which can make it difficult to find a suitable location for your business.
These zoning laws can also limit the types of businesses that can be operated in a particular area. This can present a challenge for commercial investors hoping to lease their space to a specific type of tenant.
Residential property is subject to fewer zoning restrictions, making it easier to find a location that suits your needs. Additionally, there are typically no restrictions on the types of businesses that can operate in a residential area. This gives you more flexibility when leasing your space.
Lower Tenant Turnover
The turnover rate for commercial tenants is often much higher than for residential renters. This can be a challenge for commercial investors, as it can lead to extended periods of vacancy (and lost income).
Residential tenants are typically more stable, which leads to lower turnover rates. This provides stability and predictability for residential landlords.
Larger Tenant and Buyer Pool
Everyone needs a place to live, which provides residential investors with a large pool of potential tenants and buyers. This is one of the main reasons why residential real estate is such a popular investment.
The commercial real estate market is much smaller, which can limit your pool of potential tenants and buyers. Additionally, businesses are often more particular about their location than individuals. This makes it challenging to find a tenant for your commercial property.
Easier to Finance
It is often easier to obtain financing for residential real estate than commercial property. Lenders view residential properties as a lower-risk investment, making them more attractive to banks and other financial institutions.
Commercial real estate can be more difficult to finance, as lenders typically view it as a higher-risk investment. This can make it more difficult to obtain the financing you need to purchase a commercial property.
How to Choose the Best Option for You
The answer depends on several factors, including your investment goals, your budget, and your risk tolerance. If you’re looking for a long-term investment with stability and predictable income, residential real estate is typically the better option.
However, if you’re looking for the potential for higher returns, commercial real estate may be a better choice. Here are more factors to consider:
Your Investment Goals
Consider your investment goals carefully before making a decision. Are you looking to generate income from rental properties?
If so, residential real estate is usually the better option. The demand for rental properties is more stable than the demand for commercial properties, which can fluctuate based on economic conditions.
Are you looking to sell the property after a period of time? If so, commercial real estate may be a better choice. The values of commercial properties tend to increase at a faster rate than residential properties.
What’s Your Tolerance for Risk?
Your risk tolerance is an integral variable that plays a huge role in your investment decisions. Commercial real estate tends to be more volatile than residential real estate. Values can go up and down based on economic conditions, so there’s more risk involved.
Commercial real estate may be a good choice for you if you’re the type of investor who likes to take risks. However, residential real estate is usually a better option if you prefer a more stable investment.
Commercial real estate tends to be more expensive than residential real estate. If you’re working with a limited budget, residential real estate is usually the better choice.
However, if you have more money to invest, commercial real estate may be a good option. Furthermore, commercial real estate usually requires a larger down payment.
Commercial Real Estate vs Residential Real Estate: An In-depth Guide
So, commercial real estate vs residential real estate? There is no right or wrong answer when it comes to choosing between commercial and residential real estate. It all depends on your investment goals, budget, and tolerance for risk.
Carefully consider all of these factors before making a decision. Whichever option you choose, make sure you do your research and invest wisely.
We hope you enjoyed this guide. For more information on investing, check out our other blog posts.