Since commercial and residential real estate are the two main categories of the different types of real estate, many investors ask the question, “Commercial vs. residential real estate investing — which is better?”
Both types of property—commercial and residential—can contain excellent investments, so choosing between commercial and residential real estate investing is not a quick decision. Each type of real estate investing has its advantages and disadvantages.
When asking which is better between commercial and residential real estate investing, there is no correct answer that is universally true because neither type of real estate investing is inherently superior. It depends on your personal needs and situation, including your goals, risk tolerance, liquid cash, and available time.
For most investors, investing in residential real estate is likely more accessible than commercial property; single-family homes and small multi-family properties are more readily available, easier to find and finance, and usually have plenty of rental demand from tenants. On the other hand, commercial real estate can often provide a better opportunity to scale your portfolio and generate a more robust return on investment than residential properties. However, commercial properties can also be more challenging to acquire.
Before we get too far into the details comparing commercial vs. residential real estate investing, let’s first review the difference between residential and commercial real estate.
What Is The Difference Between a Residential And Commercial Property?
Residential real estate consists of single-family homes and small multi-family properties that contain two- to four-unit properties (duplexes, triplexes, and fourplexes). Commercial real estate is property used for commerce or revenue generation. There are multiple types of commercial real estate, including commercial multifamily (5+ unit buildings), industrial, retail, office space, hospitality, special purpose, and land.
What are the Benefits of Commercial Real Estate Investing?
Commercial real estate can benefit investors in ways that residential real estate can’t. These benefits include:
- Forced Appreciation: Residential real estate is valued by comparing a property with similar properties in the area that have recently sold. Commercial real estate is valued based on the amount of income the property generates. Therefore, if you acquire a distressed commercial property with under-market rents, renovate the building, and place new tenants in the building with higher rents, you can “force” appreciation or directly cause the value of the building to increase.
- Triple Net Leases: Triple Net Leases (NNN) are a standard and highly beneficial lease that you can use in commercial real estate. In a NNN lease, the tenant is responsible for all property expenditures, including real estate taxes. This means the property owner only needs to pay the mortgage for any structural repairs/improvements outlined in the lease.
- Longer Lease Terms: Residential lease terms are usually one year or less because tenants like to have the opportunity to leave. People’s lives tend to change more frequently than a business because a person may need to move if they accept a new job, have a life change, or just want to uproot and go somewhere else. On the other hand, businesses often don’t want to move; they want to establish familiarity and credibility in their location and don’t want to rack up costs associated with moving all of their equipment, employees, etc. Because of this, it’s common for commercial leases to be more than ten years long.
- Higher Returns: It’s possible to find great returns in residential real estate. However, commercial real estate tends to yield better returns over the long haul.
Benefits Of Residential Real Estate Investing
While the benefits of commercial real estate investing are great, it’s also essential to consider the unique benefits of residential real estate investing. Here are a few worth noting:
- Cost of Entry: It’s no secret that you need capital to invest in either type of real estate, and the cost of investing in residential real estate is almost always less than investing in commercial real estate. Sure, you can likely find a luxury condo in an expensive city for more than a commercial property in a rural town. Still, when you compare residential to commercial properties in the same market, the commercial property will likely be more expensive. Because of this, it may be easier to save for the down payment of a single-family home than it is a commercial property to get started.
- Consistent Demand: Population growth is outpacing the number of residential properties currently and for the foreseeable future. This means we should see consistent demand for residential real estate for a long time as most people want a place to call their own. If you’re ever in a bind and need to exit a residential investment, there’s a good chance someone out there will be willing to buy it.
- Opportunity to Self-Manage: Large commercial properties aren’t for everyone. Some investors prefer owning a smaller portfolio with 100% control and not having to split that with anyone else. Being able to self-manage means you make all of the decisions related to your properties without having to answer to other investors. This is a huge benefit to some investors.
Now that we’ve reviewed some of the benefits of each type of real estate let’s explore other commonly asked questions about commercial vs. residential real estate investing.
What is more expensive commercial or residential real estate?
Assuming both types of real estate are in the same market, commercial real estate tends to be more expensive than residential real estate. There are certainly instances of a luxury condo in New York City costing more than a commercial building in rural North Dakota. However, when comparing within the same market, commercial real estate tends to be more expensive than residential real estate.
Why is commercial real estate more expensive than residential?
Commercial real estate tends to be more expensive than residential real estate for a handful of reasons, including:
- The Proportion of Allotted Land: Every city is responsible for zoning the use of real estate. Most cities zone more favorably for residential real estate than commercial real estate. With this, the nature of supply and demand kicks in; as space for new commercial real estate becomes less available, the cost of existing commercial real estate rises.
- Bigger Players: Individuals, couples, and families are typically the main buyers for residential real estate. As a result, the funds that residential buyers use to acquire property comes from the same paychecks that also need to cover food, insurance, clothing, and other day-to-day essentials so the buying power for residential real estate tends to be more constrained. Banks, professional investors, and private funds are the primary buyers of commercial property and they bring a significantly larger “war chest” of capital to acquire properties. With this, they have more to spend and can drive prices up quickly if they really want a property.
- Higher Rents: Since commercial properties are leased out to businesses as tenants, investors have a more realistic opportunity to secure top-dollar for their rent. A healthy business can often afford to pay more in rent than an individual so commercial properties often have greater rental yield percentages than residential properties. Higher rents in commercial properties mean higher valuation.
Are Commerical Real Estate Utility Rates More or Less than Residential Utility Rates?
Commercial real estate utilities are the same as residential real estate utilities in that they receive the same water, electricity, sewage treatment, etc. However, because commercial property owners frequently purchase their utilities in bulk for business, the utility providers in the area usually offer discounts for commercial properties.
What’s the Difference Between Commercial Real Estate Loans and Residential Real Estate Loans?
Residential loans are primarily given based on the strength of the borrower. This means that to secure a residential loan, the buyer needs to have strong credit, sufficient and reliable income, and enough liquid cash to purchase a property (among other criteria). Commercial loans are primarily given based on the projected ROI of the property. This means that if a property will be able to provide a reasonable return on the borrowed capital, the bank will often help fund the deal.
Another key difference is the amount of money you need to produce for a down payment. It’s possible to secure a residential real estate loan (as a primary residence) for as little as 3.5% down whereas you will often need to put 20–30% down to acquire a commercial property. Additionally, you can work with active investors and passive investors to pool money together so that you pay less or no money out of your own pocket for the acquisition costs.
Finally, the terms, conditions, limits, and penalties for commercial real estate loans are very different than residential real estate loans. Residential loans are usually financed over 15 or 30 years with fixed-rate mortgages. This length of time helps create lower monthly payments that homeowners are better prepared to pay consistently over the long-haul. Residential loans are also amortized during the full duration of the loan to ensure the loan is fully paid off at the end of the term and the owner fully owns the property by the end of it. Commercial loans, on the other hand, can often range from six months to twenty years with the amortization time usually being greater than the loan term. This is because many commercial investors only plan to hold the property for five to seven years before selling it and rolling their gains into a new deal.
What makes more money commercial or residential real estate?
Both types of real estate can make money with strong returns on investment. In terms of sheer volume, learning to invest in commercial real estate is arguably more likely to make you more money over time. However, like all investing, this is highly dependent on the individual, the individual’s decisions, and the individual’s unique circumstances.
Is it better to invest in residential or commercial real estate?
Any property, whether commercial or residential, can be an excellent investment as long as you’ve done your due diligence and have good reason to expect the property to perform. In this instance, the word “better” is entirely subjective to what you want to achieve as an investor.
Can you do both commercial and residential real estate?
Yes! It’s entirely possible to invest in both commercial real estate and residential real estate. Nothing prohibits you from investing in both types of real estate if that’s what you want to do as an investor.
Summary
There are many factors to consider when comparing commercial vs. residential real estate investing. Always keep your personal situation and goals in mind when making your decision, and remember that you always reserve the right to change your mind or strategy later.
