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Real Estate

Commercial vs. Residential

Blaine Annett
I
December 30, 2021

Commercial vs. Residential: Differences in Real Estate


It isn't easy to decide between residential and commercial real estate investing. Each strategy has its advantages and its challenges. The path of an investor will vary depending on their goals, risk tolerance, and liquid capital. Before making your final decision, be sure to review the following benefits.


What is the difference between a residential and commercial property?


Technically, residential real estate differs from commercial property in that it includes single-family homes and one to four-unit rental properties. On the other hand, commercial property is any property with five or more units. Residential real estate includes condos, duplexes, and quadruplexes. However, office, retail, industrial and multifamily (of five or more units), hotel, and special purpose buildings are classified as commercial real estate.


A stark distinction between residential and commercial properties lies in the type of tenant each building attracts. Commercial properties are usually leased to businesses, while residential properties are often leased to individuals and families.


Each property type offers different opportunities. As a result, investors have a more comprehensive selection of investment options in commercial real estate. There are, for example, more commercial property investment funds available than residential ones. On the other hand, residential real estate investing tends to give investors more control over the property.


Benefits Of Commercial Real Estate Investing


Higher Returns: Commercial properties offer higher returns and greater risk. Commercial property returns and cash flow are more appealing than residential property returns. The National Council of Real Estate Investment Fiduciaries, Property Index, states that commercial real estate investments earn an average annual return of 12.7 percent compared with the S&P 500's 8.8 percent average annual return over the past 15-years. You will have more tenants and more money. Investors looking to diversify their portfolios will find this advantageous.


Qualified Tenants:  It can sometimes prove difficult for investors to find qualified tenants to rent their single-family or small multi-unit property. Commercial tenants are usually businesses or corporations. They are more likely to follow the rules and respect the property because they have backing from a larger company. Qualified tenants can make the life of property owners easier, although this isn't always true.


Triple Net Leases: Although triple net leases are not always possible, they can be highly beneficial for commercial realty investors. Triple net leases do not require the property owner to pay for any property expenses. Instead, the lessee pays all property expenses, including real estate taxes. Large companies, such as Walmart, Target, and Starbucks, will sign this type of lease. Large companies typically sign this type of lease (think Starbucks, Target, Walmart, etc.) to keep their brand consistent. They manage the costs, and the investor pays virtually nothing in maintenance. It's a win-win situation. Investors can take many net leases, but a triple net lease is beneficial for commercial properties.


Longer Lease Terms: Commercial lease terms are typically longer than residential ones. Residential properties usually range from six to twelve months. Commercial properties can be leased for five to ten years. This means that investors will have lower turnover costs and vacancy rates. For those concerned about the marketing of a property year after year, long lease terms signify reliable and positive cash flow. However, for long periods, commercial investors may end up with less desirable tenants than they would like. Investors can still avoid long-term problems by following the correct application process and ensuring that they have legal protections.


It is easier to increase value: The way property values is one of the most significant differences between residential and commercial realty. Commercial real estate is directly affected by its revenue, even though comparable properties are a considerable influence on residential real estate. The more cash flow a commercial property generates, the greater the property's value. Investors could experience a greater appreciation in value than residents if they have the right tenants.


Intelligent investors understand that it is crucial to weigh all aspects before making an investment decision. These benefits of investing in commercial real estate are undeniable.


Benefits Of Residential Real Estate Investing


Cost of Entry: Although it is possible to get commercial real-estate loans as a novice investor, residential real estate investment is much more affordable than commercial real estate. While the average person might not have enough money to pay a sizeable down payment on a commercial property, they are more likely than others to save enough for a single-family home. A commercial property may seem overwhelming to a new investor. However, once they have purchased several cash-flow-producing residential properties, they will likely have the capital and experience necessary for investing in a commercial building.


Decreased Tenant Turnover: Tenant turnover has declined for residential investors, mainly focusing on single-family homes. Tenants that make up commercial properties are often the ones who change and grow with businesses. It can be hard to keep tenants occupied for extended periods when there is so much volatility. It is, therefore, necessary to find tenants more often than once in a while. If you are a residential realty investor and market tenants properly, you will find long-term tenants who are willing to rent your home. You can feel more secure if you only focus on long-term tenants.


More lenient zoning laws: Commercial investing brings with it a lot more paperwork for property owners. As a result, zoning laws can be more stringent, and building permits can be harder to obtain. On the other hand, residential real estate regulations and rules are more flexible and smaller in scale.


A more significant buyer and renter pool: Everyone needs somewhere to live. A larger pool of potential buyers and tenants for residential real estate is better than commercial real estate, depending on businesses. Investors may have a more challenging time attracting commercial tenants in specific markets as companies adapt to the online marketplaces and remote work opportunities. Nevertheless, this is an excellent opportunity for investors regardless of the market because there is a high demand for residential real estate property.


Performance is better in an economic crisis: Commercial investors can be affected by the impact of an economic downturn on their businesses. Commercial property owners trying to attract tenants during a downturn in the economy may find it challenging to market their property. These challenges are not unique to residential real estate. However, residential property owners can benefit from the fact housing is always in high demand, regardless of economic conditions. It is not guaranteed that a company will remain in business during a commercial lease. Commercial investors who depend on long-term tenants can face a unique problem.


Both residential and commercial real estate investing has its positives and its negatives. Therefore, it is essential to evaluate the benefits of each strategy and decide which one suits you best.


Comparing Residential and Commercial Loans


Banks typically distribute residential loans or residential mortgages to borrowers. A commercial mortgage is issued to a company, and unlike residential mortgages usually distributed between individuals and banks, it's made to companies. A business entity representative generally signs a commercial mortgage for tax purposes. The property is zoned to be used for business purposes.


Commercial loans are also considered riskier than residential loans. Commercial loans have higher interest rates and shorter terms. Why? Because commercial lenders have a secondary market that is independent of traditional banks.


Investors must have a business plan and solid credit scores to be eligible for a commercial loan. Commercial lenders care more about the property's cash flow projections than residential lenders. Before approving a loan, they will need to know who will pay the utilities and what kind of maintenance will be required.


The terms, conditions, restrictions, and penalties for residential and commercial loans are very different. Homeowners often finance their homes over a long period. Typically, 30-year fixed-rate mortgages. Residential buyers have many loan options, but this one is the best due to the more extended amortization period and lower monthly payments. Residential loans are usually amortized over the loan term to pay off at the end entirely. Commercial loans have words that are typically longer than residential loans. The amortization period for commercial loans is usually between five and 20 years. Commercial lenders can also customize loan repayments to meet the needs of each borrower.


Comparison of residential and commercial electricity rates


Both residential and commercial properties use the same quality energy. Electric companies offer different tariffs and discounts because commercial property owners often buy large quantities of electricity. This allows business owners to purchase electricity at a lower rate. Electricity companies can recover sufficient funds to buy electricity in large amounts due to the volume they need.


What is passive commercial investing?


Individuals can invest passively in commercial real estate property by becoming limited partners with commercial realty companies. An investor can become the direct owner of a commercial property, but it is usually challenging to get into the market due to the high capital requirements. A great exit strategy for those who want to make a living from real estate is rehabbing, prehabbing, and wholesale commercial and residential properties. Investors who wish for a more balanced and diversified approach to real-estate investing might be better to rethink these strategies and instead opt to build a portfolio that includes passive commercial real estate property investments.


Comparing Commercial and Residential Building Costs Residential Building Costs


Even though the properties may be similar in size, residential and commercial real estate costs can vary widely. Material, overhead costs, compliance standards, labor, and equipment are all factors that can affect the cost of commercial vs. residential real estate.


Commercial properties can have significantly higher costs due to the need for skilled workers and equipment only used for commercial construction. The overhead costs, labor, and equipment associated with residential real estate can be very high. But, residential real estate is often less expensive than commercial because it is built on a smaller scale.


Commercial Vs. Residential Real Estate Agents


There are many similarities between residential and commercial real estate agents. However, it is essential to be aware of the differences to decide which path is right for you.


Education and Training: All real estate agents must complete education and training to get a license. Commercial realty agents need to have a college degree in finance or business to understand better the financial concepts behind the deals they will be dealing with. Mentorship training is also required.


Property types: There is a clear distinction between the two realty agents. It is the type and use of the property they are working with. Commercial agents may encounter a property used for more than one purpose. Residential real estate agents work only with residential properties. Therefore, commercial property agents must differentiate between residential and commercial property transactions.


Earnings: Commercial real estate tends to have a more significant earning potential than residential. Commercial agents can achieve a more substantial commission on the sale of residential properties than it is to take a residential property off the market.


Clients: Residential properties can be easier to sell because of economic factors that impact the commercial real estate market differently. Commercial real estate clients are more challenging to find tenants for their properties than residential agents.


Work life: There are many differences in the work schedules and responsibilities between residential and commercial real estate agents. Residential agents can work irregular hours, even weekends and evenings. On the other hand, commercial real estate agents tend to work from 9-5. As a result, commercial agents have a heavier workload. They will need to research and report on economic and market trends to close more complex deals.


Summary


It isn't easy to choose between residential and commercial investment properties. Each has its benefits and drawbacks. Each will diversify your portfolio and offer significant tax benefits. Both will help you get closer to financial freedom.


Answering that question depends on the investor's goals for real estate investing. It is essential to take the time to consider their long-term and short-term goals when investing in real estate. For example, a residential property that is being renovated or wholesale might be a good option for those looking to make a profit quickly. On the other hand, commercial properties can offer many attractive advantages for those looking for passive income and want to be in the business long-term.


Commercial real estate is a good investment option if you look to make the highest returns. However, if you are more comfortable working on smaller scales, residential properties might be more appealing. It can be easier to choose where to invest your money by considering how much time and risk you are willing to put into your project.


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