Commercial vs Residential Real Estate Investing
Real estate has always been a good investment, but how well your property generates a return on your investment depends on which type of property you choose and your planned investment strategy. Investing in commercial real estate or residential real estate can generate a steady cash flow from rentals and leasing, or quick profits made with wholesale residential investments or house flipping.
Here we’ll discuss the benefits of both commercial vs residential real estate investing and the different ways you might look to finance each.
Residential real estate is typically a non-commercial property with up to four independent units that are rented to residents for domestic living. These include single-family dwellings and multi-unit apartment buildings. In contrast, commercial properties will contain 5 or more living spaces, such as hotels and mixed-use retail/living spaces.
By contrast, any structure used for conducting business is considered commercial real estate. These include offices, stores, industrial and special-purpose buildings like storage facilities.
When investing in residential real estate, make sure you have specific and measurable goals. For example, do you want to be a landlord and work with tenants and contractors? Do you know what you need the property to generate to create the type of return on your investment you expect?
The following types of residential properties are typical for residential real estate investing:
- Single Family Homes
Benefits of Commercial Real Estate Investing
There is a wide variety of commercial real estate investment opportunities, including vacant lots, apartment buildings, retail, office buildings, RV parks and even student housing. Many investors look to commercial real estate as a hedge against inflation. Adding commercial real estate to your long-term mixed-asset portfolio is a good way to take advantage of a robust economy and generate a stable income, sometimes even during mild economic downturns.
Here are more key benefits for investing in commercial real estate:
Commercial property does present greater risk, but you can also realize more profit. The National Council of Real Estate Investment Fiduciaries (NCREIF) statistics show commercial real estate investments have an annual average return of 12.7 percent (compared to just 8.8 percent for residential properties) over the past 15 years.
Commercial property owners tend to deal with lower turnover because of the type of tenants they lease to. Business owners will usually happily lease for longer periods to recoup the costs of converting a space to meet their needs. There’s also a greater success opportunity for brands that become a fixture at a location and in a community
There are a number of tax deductions waiting for commercial property owners. Some deductions can include interest payments on expenses, property depreciation and expense write-offs related to maintenance and renovations.
Longer Lease Terms
Residential rent leases typically extend from one year to the next. But commercial leases commonly range from 5 to 10 years. Longer lease terms can create positive cash flow for many years and with fewer administrative hassles.
Benefits of Residential Estate Investing
There are a number of benefits that make residential real estate investments a viable and intriguing option for investors. From cost to potential ROI, residential real estate may be the route to take if you’re looking for alternative investment opportunities to balance your portfolio.
The down payment on a residential investment will be considerably less than commercial properties. Often, it’s through successful investments in single-family homes and multifamily dwellings that real estate investors can eventually enter commercial real estate.
Residential property owners will benefit from the less restrictive zoning laws and building permits for residential property. Also, in certain disadvantaged communities called opportunity zones, real estate investors may be eligible for tax cuts and other incentives. Do not discount low-income communities - simply do your homework, because many urban areas are experiencing an influx of middle-class renters and community revitalization which will continue to increase property values.
There is a larger pool of both buyers and renters for residential property. Therefore, finding quality tenants is not as difficult since there is a higher demand for good residential rental properties these days.
Less Impact During Economic Crisis
During economic downturns, many commercial businesses may be forced to shut down operations. It’s less likely that you will lose residential tenants during an economic crisis because the trend for families would be to stay put and not endure the costs of relocating.
Residential Loans vs Commercial Loans
Financing will vary for commercial vs residential real estate investing. Lenders will generally consider commercial loans as being riskier, so they can be more difficult to obtain and may have higher interest rates. Also, keep in mind, the length of the loans is typically longer for residential properties, typically 30 years versus 5 to 20 years for commercial property.
You’ll find the terms for commercial loans more restrictive, and penalties will be higher with an amortization period that extends beyond the term of the loan. The down payment required for residential real estate sales can be as little as 3 percent, depending on your loan type and your credit score. For commercial property, lenders often require a 20 percent down payment.
Most people looking to invest in residential real estate will work with their personal banker for financing. Since the down payment and other costs for commercial loans are so much higher, investors often look to crowdfunding for commercial real estate. This is when a group of individuals provides financial support to fund a project with an expected return-on-the investment.
Commercial property loans are distributed by the same lenders that finance business ventures. Be prepared with a business plan, a solid credit score and a prospective property that’s in good condition and in a good location for commercial success.
If you’re interested in commercial or real estate property, it’s important to understand the pros and cons of each opportunity. Choosing between commercial or residential real estate can be a subjective decision. When it comes down to it, you need to identify your goals, and your risk tolerance, so you can invest in the opportunity that’s right for you.
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