Deciding between Commercial Real Estate and Residential Real Estate investing is not a decision made overnight. Each strategy offers its own set of profit as well as its own set of challenges. The path a real estate investor chooses to take will depend on their goals, risk tolerance, liquid capital, and time.
Commercial property, also called commercial real estate, investment property or income property is real estate intended to generate a profit, either from capital gains or rental income.
Residential real estate:
It consists of housing for individuals, families, or groups of people. This is the most common type of estate.
Benefits of Commercial Real Estate Investing
Higher Returns:Compared to the returns on residential properties, commercial property cash flow and returns are far more attractive. More space equals more tenants, which equals more money in your pocket. Not bad for an investor looking to diversify their portfolio.
Qualified Tenants: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 tenants 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 tenants will make any property owner’s life easier.
Triple Net Leases:
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. Big companies will typically sign this type of lease to maintain a look and feel in line with their branding. So they manage those costs while the investor pays practically nothing in maintenance costs.
Longer Lease Terms:Commercial leases tend to be much longer when compared to residential properties, which typically range from six to 12 months. 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.
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.
Benefits of Residential 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 Tenant Turnover:For residential real estate investors, especially if their focus is on single-family homes, tenant 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. This means more work has to go into finding tenants regularly instead of once in a blue moon. 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 Zoning Laws:With commercial investing comes far more red tape to deal with as the property owner. Zoning laws are more strict, building permits are harder to come by, etc. With residential real estate, rules and regulations are more lenient and smaller scale.
Larger Buyer and Renter Pool: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 owners 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 tenants.
Risk versus rewards between commercial and residential properties
Tax benefits:Commercial and residential properties that are let out attract tax on income from house property. However, in some cases, a house property that is taken on a home loan, qualifies for tax breaks under Sections of Income-Tax Act.
Risk and volatility:Investment in residential property is more risky and volatile as compared to investment in commercial properties. It is due to: frequent change in tenants; higher maintenance; and Upkeep costs and lower returns. Whereas, commercial properties offer stable, long-term rentals, with predictable income streams.
Entering and exiting an investment:Both are illiquid assets. However, with Real Estate Investment Trust (REIT) regulations, it would be easier to create a portfolio of commercial properties than residential properties. Also, since the supply of Grade A pre-leased assets is low, the demand is much higher, making it more liquid than residential properties.
Above all these considerations, it is also important to examine the location, investment size and tenure, before making the final decision to invest in a residential or commercial property.
Benefits and drawbacks of investing in residential property
Lower entry ticket
Low rental yields / rental incomes
No minimum / lowest size applicable
Investment in interiors, etc., to make it rent-friendly
Loan facilities easily available
Rental agreement usually cannot exceed 36 months
Leasing process is usually easier
Comparatively lower holding period for returns, as against commercial property
Benefits and drawbacks of investing in commercial property
Higher rental yield and returns
The capital values of commercial properties tend to remain stable for longer periods of time
Longer term lease possible, i.e., up to nine years
The property may need to be of a specific minimum size, to be commercially viable
Leasing can be in bare shell or warm shell
Difficult to offload, as there are fewer buyers in the market
Commercial values are not very volatile