Interested in diving into the real estate investment world? It’s not a decision to take lightly, and when deciding between commercial vs. residential real estate, more thought should be devoted to making sure the decision works for you in the long run. Investing in any asset is not a decision that can be made overnight. Each strategy offers its own set of benefits as well as its own set of challenges. An investor’s path will depend on their goals, risk tolerance, liquid capital, and time.
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What is the Difference Between a Residential and Commercial Property?
The technical difference between a residential and commercial property used to be blurred, but there are now more definite guidelines for each.
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 makeup residential real estate. Condos count because each unit is considered one entity, despite being part of a larger building.
Office, retail, industrial, multifamily, hotel, and special purpose buildings are considered commercial real estate.
Another important difference between commercial and residential buildings is in the type of tenant each building attracts. Residential properties are typically leased to families and individuals, while commercial properties are leased to businesses.
Lastly, each property type comes with a different set of opportunities. Commercial real estate tends to award investors a much wider range of potential investments.
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.
Pros and Cons of Commercial Real Estate
No matter the investment it’s important to consider the pros and cons before making a final decision. The benefits of commercial real estate investing far outweigh many of the cons of this type of investing.
- Easier To Increase Value – One of the biggest differences in residential and commercial real estate is how property values are determined. While comparable properties largely influence residential real estate, commercial real estate is most directly impacted by its revenue. The better a property performs, the more its worth. With the right tenants, investors could see an increase in value at a much faster rate than residential housing.
- 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.
- 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.
- 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.
Pros And Cons Of Residential Real Estate Investing
Both commercial and residential real estate investing have positives and negatives. To decide which strategy is right for you, it’s important to review the benefits and determine which ones align more with you and your business’s core values.
- 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 they are much more likely to 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.
- 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 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 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.
Choosing the Right Real Estate Investment: Balancing Risk, Return, and Personal Goals
Deciding which type of real estate investment is better for you, commercial or residential, requires careful consideration of your goals, risk tolerance, and investment strategy.
Commercial real estate offers higher potential returns on investment but requires a significant upfront investment, a longer-term investment horizon, and a willingness to take on higher risk. On the other hand, residential real estate offers a lower entry barrier, a stable rental income stream, and a broader pool of potential tenants but may have lower appreciation rates and higher tenant turnover rates.
Ultimately, the best type of real estate investment for you depends on your investment goals, risk tolerance, and financial situation. If you have a higher risk tolerance and a long-term investment horizon, commercial real estate may be a better choice. If you are looking for a stable rental income stream with a lower upfront investment, residential real estate may be a better fit. Consider working with a financial advisor or real estate professional to help you make an informed decision based on your specific circumstances.
Residential Real Estate Vs Commercial Investing
Choosing between a commercial vs. residential investment property is no easy decision, especially when you consider both of their sets 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.
But real estate isn’t the only option, and for those looking to diversify their portfolios, income funds might be a great option to consider.
No matter your financial goals, Saint Investments is here to help. Our financial services specialists leverage years of experience to provide the best advice, no matter your financial goals.
Frequently Asked Questions:
Commercial real estate includes office structures, retail spaces, warehouses, and industrial properties, among others.
Residential real estate refers to properties designed and used for accommodation, such as single-family homes, townhomes, condominiums, and apartment structures.
In terms of purpose, features, and financial potential, commercial and domestic real estate are two entirely different beasts. Business real estate is built with the ultimate goal of making money for a company, either through renting out space or selling the property at a profit. Domestic real estate is built specifically for the purpose of sheltering its occupants.
The longer-term rental revenue sources and greater investment possibilities of business properties make them generally more expensive than comparable domestic properties.
Generally, when considering the two types of real estate investments, residential real estate is a better choice for people who are new to investing due to its lower upfront investment requirements, easier access to financing, and lower risk. However, making a decision between the two types requires sufficient knowledge of the market, the ability to answer important investment questions, and an understanding of the key factors to consider such as the intended purposes of the investment, the level of risk tolerance, and the potential returns on investment. For experienced investors with a higher risk tolerance, commercial real estate can offer higher returns on investment.
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.