Residential or Commercial Real Estate: Which is a Better Investment?

Even with the market dips and spikes, real estate remains one of the most consistent and dependable investments in the United States. The benefits of residential real estate even bring on an influx of foreign investment in U.S. real estate. Whether you need a source of passive income or want to take advantage of tax benefits, there’s a wide range of the benefits of investing in real estate.

If you do decide to invest in real estate, you have your choice between residential and commercial properties. Both come with their own pros and cons. So, which makes the better investment, commercial or residential real estate? Read on to learn more.

Commercial Real Estate vs Residential Real Estate: Understanding the Difference

In practice, it’s easy to tell the difference between commercial and residential properties. One is for business, while the other is for people to live in, but that is oversimplifying and ignoring some of the nuances involved within each category.

What is Residential Real Estate?

In terms of usage, residential real estate is designed for individuals or families. It can comprise undeveloped land, houses, townhouses, and condos, which can be occupied by the owner or rented out to others. That includes single family homes and multifamily rental residences. However, any multifamily property that comprises five or more units is considered a commercial property.

What is Commercial Real Estate?

Commercial real estate is leased to businesses. Commercial properties can be freestanding or comprise parts of shopping malls or strip malls. Most all nonresidential structures are considered commercial real estate, including:

  • Office buildings
  • Warehouses
  • Retail buildings
  • Hotels

As mentioned, any multifamily apartment buildings that comprise five or more units are also considered commercial real estate.

However, commercial real estate is separate from industrial real estate, which includes factories, business parks, farms, and mines. These are generally practical spaces for the manufacturing of goods. Industrial properties are much larger in square footage and typically built to include access to rail lines, harbors, and other transportation hubs.

The Benefits of Investing in Residential Real Estate

Low Barrier to Entry

Homeownership is the most common form of real estate investing in the United States, and with good reason. The cost of investing in residential real estate is significantly lower than for investing in commercial real estate. That ultimately makes for a low cost of entry. You may not have enough saved for the down payment on a commercial property, but you can generally work with a bank and invest a minimal down payment on a single-family home. If you happen to get a good single family rental cap rate, then you may even be looking at a very successful investment.

The same applies to experience. If you are purchasing a single-family home or residential property, you can get approved with next to zero experience. Commercial real estate properties require more experience, including knowledge of rent in the area, property maintenance, financial analysis, expense management, and more.

Reduced Tenant Turnover

Tenant turnover is a constant issue with commercial real estate. Businesses that fail inevitably mean that they will not be able to keep the space. Businesses that grow will likely want to move elsewhere to expand their operations. That constant change and growth means high volatility that can contribute to ongoing challenges with keeping tenants in a commercial space. That also means more time spent looking for potential tenants on a regular basis.

By comparison, tenant turnover usually is not something that residential real estate investors need to deal with often, especially if you have a property management company that takes care of tenant placement. If you are investing in a single-family home that is your own primary residence, tenant turnover is a non-issue. For rental residences, you can screen potential tenants and easily find people committed to long-term rentals. Even without these long-term tenants, you can almost always find someone to rent to. Simply put, people always need a place to live, and considering the growth of freelance and self-employment, home offices are quickly becoming as popular as actual offices.

Larger Rental Pool

Related to the above, residential real estate naturally benefits from having a larger pool of potential buyers and tenants. Commercial real estate properties are limited to businesses, while residential rental properties seemingly apply to any living human who can afford it. The growth of online marketplaces and contract and remote work are invariably putting a strain on commercial real estate. On the other hand, the demand for residential real estate is a constant, regardless of the market or the state of the housing market. 

People will always be looking for a place to live and due to this demand, it’s important to seek property management services that can help you make the most of your property with high-quality tenants. For example, if you’ve invested in a property in Gainesville, FL, where there’s a booming market that makes it one of the best places to buy rental property, you’ll want to seek reputable help. Companies that offer property management in Gainesville, FL, such as Great Jones, can help you find the best tenants for your rental property. After all, having high quality tenants is key to ensuring a regular stream of income and limiting the chance of delinquent rent.

Lenient Zoning

Residential real estate typically comes with fewer rules and regulations that are considerably less stringent and at a much smaller scale, making them easier for the average investor to handle and wrap their head around. Commercial properties come with far more red tape, regulation, and oversight. Building permits are harder to obtain, while general zoning laws are strict and often complicated.

Easier Analysis

Investments in real estate usually come down to:

  • Cash flow
  • Building equity by paying down loans
  • Appreciation of property

That means that you need a general understanding of capitalization rates, return on investment, and cash-on-cash returns. It’s more to learn but relatively straightforward and common sense. Other things that are important to consider and can affect the value of your investment is residential real estate depreciation.

For commercial real estate, making money almost entirely comprises increasing net operating income. If you invest in commercial real estate, you essentially have to think of it as running your own small business. You need to consider maintenance records, rental histories, general expenses, and acquisition and value ratios. When you look into properties, you have to look at profit-and-loss statements from at least the last year. All of that ultimately adds up to needing more knowledge and time to fully understand and analyze your finances.

Reduced Maintenance Costs

While residential properties do require ongoing maintenance, it is at a much smaller scale and considerably less money, especially if you are investing in a single-family home. Most daily maintenance is performed by the tenant. For commercial real estate, the ongoing maintenance costs are significantly higher. Cleaning, repairs, and general upkeep are daily finances that tenants expect of you.

Steadfast in Economic Crises

As much as you hope it doesn’t happen, the economy has plenty of downs that could potentially result in a full-blown crisis. Residential properties are by no means immune to economic downturns, but housing is always in demand, regardless of the economy. Businesses, on the other hand, are often the first to get hit by financial crises, which presents plenty of challenges to commercial property owners. Finding commercial tenants during an economic crisis can be hugely daunting, and there is no actual guarantee that any tenants you do find will remain in business through the full terms of the lease. 

With residential real estate investing, you have the peace of mind knowing that housing is a basic necessity and so your rental property may be able to remain steadfast better than a commercial investment property would. 

Benefits of Investing in Commercial Real Estate

Easier to Increase Value

For residential properties, real estate market value usually depends on the value of other similar properties in the area based on raw characteristics. Your two-bedroom home will generally be about the same price as every other two-bedroom home in the neighborhood (with slight variations considering age, condition, and other features). 

While comparing other properties in the area still factors into commercial properties, most of the market value of commercial real estate depends on the amount of revenue that the property generates. A small but strategic improvement can dramatically increase the value of the commercial property as long as it increases the revenue.

Longer Lease Terms

Residential properties usually run about 12 months. Commercial properties usually have three-year leases at minimum with commercial leases commonly going up to 10 years. That ensures a long-term, reliable cash flow, low turnover, and low vacancy rates.

High Returns

The biggest draw to commercial real estate is the high returns. You are renting out more space to more tenants, which naturally means more money for you. However, with potential high returns comes high risks.

Choosing Commercial vs Residential Real Estate

While there’s nothing wrong with investing in commercial real estate, residential real estate tends to be a safer, more reliable, and a less volatile investment. Commercial investment does come with high returns, but it also comes with increasingly high risks, often involving factors that are not immediately within your control.

Residential real estate is simply a much easier investment property to handle, whether you are a first-time property owner or an experienced fix-and-flipper. As you gain experience, you can eventually invest in multiple residential properties for several sources of cash flow.

Sources:

Kahala Bonsignore

Kahala works on the Growth Team at Great Jones where she's dedicated to helping more Property Owners learn about Great Jones and how their partnership can increase profitability and decrease rental stress.

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