Countless people have become self-made millionaires as a result of thoughtful and patient real estate investing decisions. Even more people have used real estate as a way to make extra money on the side and prepare for retirement. But the realm of real estate investing is incredibly vast; both commercial and residential real estate investing offer considerable advantages.
Is one better than the other? And how do you decide which one to start with?
Commercial vs. Residential Real Estate Investing: The Basics
The most commonly used definitions delineating commercial and residential real estate have to do with size and the number of units available. Properties that house between 1-4 families are considered residential, while properties with 5 or more units are considered commercial.
Alternatively, properties are sometimes defined based on the tenants they want to attract; residential properties attract individuals and families, while commercial properties attract businesses. This does create some gray areas, like apartment complexes, which are typically considered commercial, despite appealing to residential tenants.
Commercial real estate deals, understandably, tend to be bigger and more complex; that’s why many commercial real estate investors work with commercial real estate brokers, who help them buy, sell, rent, and manage their properties.
Without the guidance of commercial real estate experts, it’s often hard to get started. Residential real estate deals, in contrast, are more abundant, smaller, and simpler.
So which one should you choose?
Pros and Cons of Commercial Real Estate Investing
These are some of the greatest advantages of investing in commercial real estate:
• Bigger returns. Many people are drawn to commercial real estate because of the bigger returns. These buildings are more expensive, they generate more revenue, and they can appreciate more quickly, leading to far greater profitability in general.
• More reliable tenants. In many cases, commercial properties attract more reliable tenants. Instead of searching for individuals who need somewhere to live, you’ll be searching for businesses that are already established and in search of a new place to stay, often for years or decades.
• NNN leases. Triple net leases, or NNN leases, are common in commercial real estate investing, establishing that tenants are responsible for expenses like common area maintenance, property taxes, and insurance. This reduces overhead and simplifies various profitability equations.
• Longer terms. Commercial real estate leases are often longer, sometimes stretching for decades. This leads to less risk of vacancy and more consistency.
• Straightforward value increases. Increasing the value of a commercial property is, in some ways, more straightforward than increasing the value of a residential property. The value of a commercial property is largely a function of the revenue it can generate, and it’s in your power to increase the earning potential of a commercial property in many ways.
These are some of the drawbacks:
• Property size and complexity. It’s tough to get started in commercial real estate investing because these properties are large, expensive, and complex. If you don’t have a background in real estate, this is a difficult place to start.
• Cost of entry. Commercial properties often go for 7-figures or more. If you don’t have much capital, this may be prohibitive for you.
• Laws and regulations. Commercial real estate investors must contend with zoning regulations, stricter laws, and more complex legal considerations.
• Volatility woes. Commercial real estate can also be vulnerable to volatility. Economic downturns, unexpected business developments, and more can affect your property values in unpredictable ways.
Pros and Cons of Residential Real Estate Investing
Residential real estate does have some complementary advantages, such as:
• Easier entry. Comparatively, it’s much easier to get started with residential real estate investing. The deals are simpler, smaller, and more accessible.
• Lenient zoning. Zoning regulations are also more lenient, and laws are more flexible in many areas for residential real estate.
• A bigger pool of renters. There are far more people available to rent residential properties than commercial ones. You can fill residential properties quicker in most cases.
• Less susceptibility to volatility. Residential real estate is prone to volatility, but less so than commercial real estate. An economic downturn is unlikely to cripple your residential real estate portfolio.
• Practical functionality. It’s possible to turn a previous residence into a rental property when you move out. It’s also possible to turn a rental property into a primary residence when you’re ready to move into it. For many investors, residential holdings have more practical functionality.
It also has some weaknesses to consider:
• Smaller yields. You’ll make less money with residential real estate investing, on average. The yields are smaller.
• Higher vacancy rates. Because residential tenants sometimes aren’t as qualified or as high-earning as their commercial counterparts, residential properties often have higher overall vacancy rates. Extended vacancy rates can kill any real estate investing strategy.
• Tenant management issues. Similarly, residential tenants can be more neglectful and more difficult to manage overall.
Balancing Your Real Estate Portfolio
The beautiful thing to realize here is that you aren’t limited to investing only in residential or commercial real estate. In fact, the strongest portfolios are often diversified with a mix of both. Commercial and residential real estate investments each have strengths and advantages to provide, as well as downsides and weaknesses to account for – so if you have the resources and the interest, it might make sense to maintain a mix of both in your pool of assets.
