Commercial vs. Residential Real Estate Investing: Which Is Right for You?

Daniel Penzing
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It's Easier to Increase the Value of a Commercial Property

If you've never owned a property before and you want to start with real estate investing, then it's probably best to buy a commercial property. Buying your first investment will feel a bit like "Russian roulette," where you can either hit a home run on your first property or you can lose your potential investment on your first property. That said, buying a commercial property means that you'll be using the same strategy that commercial real estate investors use. So instead of taking a risk on your first property, start out with a property that you know has already gone through the same risks that the other properties have already gone through.

So why is it easier to increase the value of a commercial property? First, there's inherently less risk to the value of a commercial property. You don't need to do massive amounts of improvements on the commercial property, especially when compared to a residential property. For example, when you're buying a residential property there's usually a lot of work that needs to be done on the inside of the property – the plumbing, the electricals, the rooms, the walls, the flooring, etc. Commercial properties don't need that same amount of work.

Enjoy Longer Lease Terms With Commercial Properties

Many commercial properties are leased for 10 years or longer. Quite often, it’s 20 years or longer. While there are many benefits to acquiring commercial properties, the longer lease term is certainly one you can highlight…to potential sellers, to your lender, to the mortgage appraiser, etc. If you are looking at a property for your portfolio, you can sit down and estimate the investment return based on 3 years, 5 years, or 7 years to be conservative. And certainly, for your own peace of mind, you want to know that you will have the ability to enjoy your investment for a minimum of at least five years and probably longer.

Investors often cite that their primary reason for investing in real estate is to have a passive income. Commercial properties generally are considered to be low maintenance, providing a passive income for the owner for the bulk of the time it is owned. From a business perspective, this fits perfectly into a cash flow plan, which is what most investors’ goals are all about. You want to invest in properties that provide cash flow and then you can use that cash flow to help purchase additional properties.

If your primary goal in real estate is to have a passive income, commercial properties are a great option, particularly if you have the funds to purchase larger and more expensive properties. One of the best things about commercial properties is that there is no limit to the amount you can borrow.

Residential Properties Perform More Consistently in Economic Downturns

Despite the face that commercial properties command higher rents and higher yields, residential properties tend to perform better, according to a bank report.

Real estate investing can be extremely rewarding, but it is also risky. One of the biggest risks is that you can lose money. If you only have a few hundred or thousand dollars to invest, this may not be a big deal. If you are investing large amounts of money, however, it could really hurt.

Real estate is not known for its stable returns, but commercial properties are even worse. In fact, the business cycle can have a very negative impact on commercial properties. It can be difficult to find steady returns.

Residential properties, on the other hand, tend to hold their value better. Even in the face of a recession, families will still need a place to live.

Residential Real Estate Investing Has Lower Barriers to Entry

One of the main differences between residential and commercial real estate investing is the level of investing experience and amount of capital required for each.

Residential investing in a single-family home has arguably a lower barrier to entry than commercial investing. You just need enough money to make a small down payment, and you can quickly move onto the next step … securing the right loan with the right terms. There’s less to teach you how to manage a property in a sustainable and profitable manner, which is one of the reasons why it’s popular with first-time investors.

Because residential real estate investing is seen as “easy money,” a lot of people end up investing in it to earn a passive income, work from home, and retire early.

While it’s true that you can earn a nice income from investing in residential properties, the story often doesn’t end there. Given the need for constant upkeep, a holiday can actually mean more work for you. Residential investing is less of a “set it and forget it” type of investment and more of a “set it and be prepared to do a bit of work” type of investment.

The Buyer Pool Is Larger for Residential Properties

If your goal is to be a landlord and rent out your properties, then the best option for you would be to invest in residential real estate. The goal of buying a residential property is to collect an income from that property, and the easiest way to do that is by renting the property out.

If you create your property portfolio for an investment with the intent of selling it in a few years, then commercial properties will be a better investment. These are properties that are great for residential real estate investing, as there are auction sites that specialize only in that market.

The downside of residential real estate is that the property has to stay rented out at all times or it could prove costly on your pocketbook. The upside? There are plenty of buyers in the market and if you’re in a decent market, you should have no problem finding a buyer. The issues with this method stem from those who struggle with maximizing their profit and those who buy the property not thinking of the future.

Commercial Deals Are More Complicated to Analyze

One of the biggest hurdles to investing in commercial properties (like shopping centers and malls) is that they require more analysis and due diligence. You see, with most residential real estate investing, you can decide whether to buy or not to buy based on the price/value or cost/benefit ratio of the deal. In other words, you can quickly assess if the deal is worth doing.

In commercial deals, however, you also need to look at all sorts of factors, including the location, room for growth, demand in the region, and much more. In some cases, the price isn’t even a big consideration, and you may even decide the deal is not worth doing if you don’t consider those other factors.

Commercial properties become a long-term play, which means you need to spend more time analyzing the deal to make sure it’s worthwhile.

You may not get as quick a return as with residential, but you also won’t lose significant amounts of your money.

Which Is Easier to Finance?

The first and most important question you should ask yourself is, "Does the potential investor have a good track record?" Most commercial investments require a higher down payment than residential investments. With commercial real estate investing, the traditional down payment is 20 percent. If you fail to pay your rent or mortgage and do not have the cash reserves, you could lose your investment.

Residential real estate investing offers a lower risk and has a lower down payment requirement. Depending on the location, many residential real estate investors can purchase an investment property for as little as 3 to 5 percent down.

Which Delivers a Better Return on Investment?

Investing in your own home can be a solid and safe investment, regardless of your current financial situation. Some properties require significant investment down, while other properties may offer lower monthly carrying costs for the real estate investor. You will need to make sure you are able to stay within your budget and have the funds necessary upfront.

If you do, here are some things that might be to your advantage:

  1. Although some banks won’t give you a loan to buy a home for you to live in, they may consider giving you a loan for an investment property, or you may qualify for a second mortgage or loan.
  2. Even if you drive a nice car and have a stellar credit score, some lenders will still consider you a high-risk borrower if you are buying a home to live in because you are likely to use some of your funds for overhead, not investing. However, if you are buying an investment property, those loans and mortgages are given much more frequently.

I'm Sticking With Residential… for Now

If you're looking to make money, chances are good that you're thinking about buying and selling real estate. If you're not quite ready to dive into commercial real estate investing, especially with all the powerful stories on television about it, you might want to consider residential real estate investing instead. It can be both easier and safer, while still offering plenty of rewards.

No Misleading Promotions

When you're buying commercial property, you'll face a sea of promotions, advertising, and buzzwords. You may have a hard time figuring out what the property is really worth, how much it's really going to cost, and if there are any hidden liens and details that you should know about. With residential, you can usually find the property with a sale price, a price per square foot, a lease price, and the down payment required. You won't have to wonder how the property was appraised, nor will you have to worry about cleverly worded sales pitches that try to mislead you.

Less Time, Work, and Strain.

Depending on the type of commercial property you're buying, there may be some additional complications. You may need zoning or rezoning. You may need a tenant that can handle all the space. You may have to arrange for deliveries. You may even have to arrange for trash removal.