What’s the Difference Between Investing in Commercial vs. Residential Property?
A potential property investment can make a great addition to a well-rounded portfolio. If investing in a residential or commercial property is what you need to decide next, then this article is for you. Whether you are considering buying a commercial property for sale in Phoenix, or a residential property for sale in Dallas, knowing which property type would be best for you to invest in will be based on several factors.
This article will not only assist investors with the decision to investigate the commercial or residential property route, or both. In addition, we’ll look at:
- How financing for commercial and residential properties shares some similarities but also has some major differences.
- How investors can accurately evaluate potential risks in different areas.
- How each type of investment offers its own unique advantages and drawbacks.
If you’re new to this type of investing, it’s best to begin with the basics. Here are definitions of the real estate types we’ll cover throughout this article.
Commercial Properties Defined
The phrase “commercial real estate,” often abbreviated to CRE, is defined as: Any property that will be used explicitly for business purposes.
These include retail, office, and industrial properties.
Warehouses are popular choices for CRE investors
A CRE property can be any of these: apartments, stand-alone business buildings, warehouses, retail spaces, daycare centers, multi-use spaces, office buildings, condominiums, movie theaters, and even parking lots.
Residential Properties Defined
The residential real estate (RRE) category only includes properties built exclusively for the purpose of living.
This includes housing that is typically rented and has often begun life as an owner-occupied residence.
- Investors who are adding their first r vehicle to their portfolio often choose an RRE. This is because the cash outlay is considerably smaller than purchasing a CRE.
- Also, the financing method is similar to applying for a residential mortgage for an owner-occupied property.
- Another advantage for beginners: selling a single RRE is generally a faster, simpler process than for a CRE.
Potential tenants of RREs are often families who prefer a neighborhood atmosphere.
Now that we’re on the subject of financing, the next section will cover the mortgage and purchasing basics for CRE and RRE properties.
Differences in RRE and CRE Financing
While you may have already guessed (correctly!) that investing in commercial space will probably require a bigger cash outlay than a residential rental property, there are more differences, too.
- While residential property mortgages usually offer 30-year terms, a CRE loan will be considerably shorter, ranging from five to 20 years.
- Amortization periods for CREs are often longer than for RREs.
- A CRE loan can finance a multi-tenant building with several floors of apartments, while a residential mortgage is usually limited to a two- to four-unit building, such as a duplex.
- A CRE loan will generally require a higher down payment than an RRE mortgage and may have a higher interest rate.
- If you plan to buy several residential properties with residential mortgages, you will be limited to 10 residential loans, although you may be allowed more properties with a co-borrower.
- Loans for CRE are usually made to business entities (corporations, developers, limited partnerships, funds, and trusts)
- Commercial loan Loan-to-Value (LTV) ratios are usually around 60-85%, while residential LTV ratios can be much higher.
Now that we’ve gone over the financing essentials for these investments, here are some other factors to consider.
Commercial Real Estate Means Bigger Investments and Bigger Decisions
If your finances allow you to consider both CREs and RREs, here are some things to consider.
Solid investment decisions are based on several factors. When real estate is involved, the most important factors are your comfort levels regarding risk and your investment timeline.
In other words, can you wait for a payoff? Will your investments or even personal finances suffer if one or more property is vacant?
- In general, CRE investments are less risky, due to the rock-solid lease terms in place for commercial tenants.
- CRE investments that are reasonably long-term (at least five years) generally have a better chance of generating more returns in the form of steady passive income.
- If you haven’t set long-term investment timelines, residential rental properties may be preferable. Generally, these can be more easily managed than commercial real estate.
- However, RREs may provide unstable cash flow because of possible shifts in market demand. For example, renters who plan to buy a home soon may depart your rental properties when the buyer’s market becomes more favorable to them.
If investing in CREs is more attractive, but you aren’t prepared to bankroll this type of purchase, you have another option: fractional ownership.
- Fractional ownership is reflected on your invested amount relative to the value of the property.
- For example, if you invest $100,000 in a commercial property worth $1,000,000 you will own 10% of the property.
- Your dividends and appreciation are based on your ownership percentage.
Last but not least, if you have local business contacts who are familiar with your area’s market demand, they can be extremely helpful when you’re ready to make a final decision.
Ready to Begin Your Search?
In closing, here are some investor basics to keep in mind when you begin viewing properties, especially if you can afford to consider both CREs and RREs.
- If possible, be sure to chat with any seasoned investors you may meet when viewing real estate. That first latte you buy for your local real estate guru can make a big difference in your long-term success.
- Commercial investors like yourself often choose to work with a property investment firm. The staff will handle the legalities, keeping your options simple: you can simply choose the investment option that passes your sniff test.
- Not sure where your residential rental market’s headed? Another option is to sublet a property for a definite lease period. There’s no purchase involved, so after the end of the lease period, you can move to another asset.
All potential investors need to do the research and acquire a thorough understanding of demand and supply to properly assess their risks and rewards.