Commercial Vs Residential Real Estate Investing: Which Strategy Is Right For You?

May 03, 2018

Key Takeaways

Investors deciding between commercial and residential real estate, they must consider their long-term goals, tolerance to risk, amount of available capital, and time they are willing to devote to the project.

Higher returns and cash flow is arguably the biggest benefit of a commercial real estate investment over a residential one.

Residential loans are typically paid off over 30 years while commercial loans are typically paid off over five to 20 years.

Deciding between commercial vs residential real estate investing is not a decision that will be made overnight. Each strategy offers its own set of benefits as well as its own set of challenges. The path an investor chooses to take will depend on his or her goals, risk tolerance, liquid capital, and time. Review the following benefits before making your final choice.

What Is The Difference Between A Residential And Commercial Property

The technical difference between a residential and commercial property is as follows: Residential real estate is all single family type homes and one to four unit rental residences while a commercial property is anything with five or more units. Condos, duplexes, and quadruplexes make up residential real estate while office, retail, industrial, multifamily (of five units or more), hotel, and special purpose buildings make up commercial real estate.

Another stark difference between commercial and residential properties is in the type of tenant each building attracts. Residential properties are typically leased to families and individuals while commercial properties are typically 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 one example, there are more commercial property investment funds than residential ones. On the other hand, residential real estate investing tends to be more hands on.

Benefits Of Commercial Real Estate Investing

Higher Returns. You’ve heard the saying…”with greater risk comes greater reward”, which is quite poignantly the case with commercial properties and 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. 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. Commercial tenants on the other hand tend to be businesses, corporations, or something of the like. Because they are backed by a larger company, 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 expenses on the property. The lessee handles all property expenses directly, including real estate taxes, so all the property owner has to pay is the mortgage. Big companies (think Starbucks, Target, Walmart, etc.) will typically sign this type of lease in order to maintain a look and feel that is inline with their branding. So they manage those costs while the investor pays practically nothing in maintenance costs. Talk about a win win. There are a variety of net leases that investors can adopt; however, a triple net lease is specifically a benefit of commercial properties alone.

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 very 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 in 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 as 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 on a regular basis as opposed to 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 be 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 not only more lenient, but also more small scale.

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’ core values.