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Pro residential by Laura Agadoni/Pro commercial by Liz Brumer
Residential Investing: The Upsides
New real estate investors often start with residential real estate and switch to commercial investing once they become more experienced. It doesn't always happen that way; some investors jump right into commercial investing, but that's not the norm, probably because the reasons new investors should start with residential investing are compelling.
Most people are more familiar with residential property than with commercial property; after all, people live in residential property, which could be a single-family home, condo, townhouse, duplex, triplex, or quadplex. Property with five or more units (like an apartment building) is commercial property, as are hotels, retail space, warehouses, and vacant land.
Although there is plenty to learn about being a landlord, it doesn't take a lot of experience to be successful. To invest in commercial real estate, you should know the industry well -- as well as you likely know residential -- and you should have the experience to make a wise purchase decision.
Higher level of difficulty
Commercial property has challenges that residential doesn't, such as maintenance. Residential property needs maintenance, although it's probably nothing you're not already familiar with. A commercial building, on the other hand, needs a higher level of maintenance and typically requires a professional property management company.
New investors also need to be able to analyze the complexity of commercial deals and to understand unfamiliar concepts, such as a triple net lease (where the tenant pays all the expenses) and how that works.
Cost of entry
It's usually more expensive to invest in commercial real estate than in residential: Buildings cost more than single-family homes. It's common for commercial real estate investments to require a 25% down payment. On a $2 million property, that would be $500,000. With residential, you can often start with a $200,000 property (or less), and even if you had to put down 25% there as well (which you might not), it would be much more affordable at $50,000 or less.
Commercial real estate investing is generally riskier than residential. Case in point: COVID-19.
In a normal economic climate, when there's a downturn, businesses are usually the first to be negatively affected. But add pandemic lockdowns to the mix and we are, tragically, seeing businesses going under right and left.
Residential real estate took a hit as well, but not as much: People still need a place to live no matter what. For that reason, residential typically weathers bad times better than commercial does.
It's never easy to deal with an investment that's going badly, but seasoned investors are generally better able to handle challenges than are new investors just starting out.
Commercial Investing: The Upsides
For first-time real estate investors, it's a big decision as to whether you focus on buying residential or commercial real estate. You will be dedicating your time, energy, and money into learning the nuances of an industry that will generate income for you for years to come -- so making sure you're choosing the right avenue for your long-term goals is important. Let's compare residential and commercial real estate to see which avenue may be a good place to start your real estate investing journey.
What is residential real estate?
Residential real estate is defined as a property that has between one and four units and is zoned accordingly. This can include single-family homes, townhomes, condos, mobile homes, or multiplex buildings. The most common investment strategies in residential real estate are short-term or long-term rental property and house flipping.
What is commercial real estate?
Commercial real estate is defined as a property with five or more residential units or a property that is rented to a business rather than an individual for personal use. This can include apartment complexes, hotels, industrial space, retail space, office space, and more. Most commercial real estate is invested in for long term rental cash flow and is rented with a variety of leases.
How do they compare?
Although there can be arguments made in favor of both residential and commercial, the decision as to which method you invest in will depend greatly on your market, the property potential itself, access to capital, and your financial goals. But when comparing the two side by side there are noticeable differences.
|Knowledge Base||More extensive||Less extensive|
|Time demands||Similar to slightly less||Similar to slightly more|
|Financing||More difficult to obtain||Easier to obtain|
|Lease Terms (for owner)||More favorable||Less favorable|
Which is the better sector to start in?
A big determinant for where to start relates to the investor's access to capital and knowledge base for real estate investing. Residential real estate can be purchased with far less money largely due to its lower price points, while commercial real estate requires a lot more money up front and has stricter lending requirements to obtain financing.
Both residential and commercial investing take knowledge and experience. Although commercial real estate is often viewed as more complex, they both require extensive due diligence by the participating investor before diving in. Due diligence for commercial properties can be more extensive up front, but once the property is acquired, a tenant is in place, and proper management systems are implemented, commercial property can be a stable income source for years to come with the added benefits and reduced risk of economies of scale.
Lease terms are where commercial properties really shine. They are usually much more favorable to the lessor. The length of the lease on commercial properties is significantly longer than residential, typically 3 to 5 years for a short-term lease and upwards of 10 years for a long- term lease. It is important to note, however, that businesses are much more sensitive to economic downturns and do have a high rate of failure, so even with a long-term lease, it doesn't guarantee that the tenant will be in the property the entire duration. It's also possible to negotiate for all improvements on the building and even maintenance for the duration of the lease to be made by the tenant rather than the owner, which means less out of pocket and time for the investor.
Argument can be made for either side, but commercial often shines
Commercial real estate may take a bit more time to learn up front, but the long-term rewards and ease of management can make it an ideal way to start your investing journey. As with any investment, though, it's important to determine your personal comfort level before making any decisions. Remember that any deal no matter how big or how small can have similar issues, so don't let the size of the deal scare you away if the well-researched business fundamentals are there.
Unfair Advantages: How Real Estate Became a Billionaire Factory
You probably know that real estate has long been the playground for the rich and well connected, and that according to recently published data it’s also been the best performing investment in modern history. And with a set of unfair advantages that are completely unheard of with other investments, it’s no surprise why.
But those barriers have come crashing down - and now it’s possible to build REAL wealth through real estate at a fraction of what it used to cost, meaning the unfair advantages are now available to individuals like you.
To get started, we’ve assembled a comprehensive guide that outlines everything you need to know about investing in real estate - and have made it available for FREE today. Simply click here to learn more and access your complimentary copy.