Commercial vs. Residential Real Estate Investing: An Overview
So you want to be a real estate investor.
Awesome! Have you thought about commercial vs residential real estate? Some investors choose to go the commercial route, while others prefer to park their money in residential real estate.
Which option is better for you?
Keep reading to make the best choice based on your interests and investing style.
What is commercial real estate?
Commercial real estate is any property you buy for investment purposes. In most cases, if you have renters, you’re probably in the commercial real estate business.
Examples of commercial real estate include office and retail space, industrial facilities, apartment buildings, and multi-family homes, among other things.
How to invest in commercial real estate
Before you put any money to work, you need to do some research and form your investing strategy. For example, you may want to invest in office buildings or industrial spaces. Or you may want to invest in telecommunications properties. Which industry speaks to you?
Forming a strategy early on can help you narrow down your options and possibly discover opportunities you didn’t know about.
Once you know what kind of commercial real estate you want to invest in, here are some ways to get started.
Check out crowdfunding opportunities
Not everyone wants the stress of owning physical properties and managing tenants.
If you’d prefer a more hands-off approach to real estate investing, you should consider crowdfunding platforms — such as Fundrise and CrowdStreet — that let you put money into real estate investment trusts (REITs). In some cases, they also let you invest money directly into properties.
Offer direct lending
If you have the cash, you may be able to provide direct lending to other real estate investors.
Using this strategy, you can provide limited or full funding to a single borrower and set your own financing schedule and interest rates.
The 3 classes of commercial real estate investments
As with any investment, you should do your research and know what you’re getting into before you put your money to work in any commercial real estate opportunities. Study the local real estate market and the buildings themselves — commercial properties are broken down into three categories: A, B, and C properties.
Class A properties are the newest buildings, typically in the most lucrative areas. These tend to be the most expensive but most profitable investments.
The next tier is class B, which are buildings that are a bit older but still in great condition and located in desirable areas.
Class C properties are older and may be in poor condition. They tend to be located in areas that are less than desirable. They are less expensive but may have higher maintenance costs or require extensive refurbishing.
Know how much risk you’re willing to take on and don’t invest outside your comfort zone.
What is residential real estate?
First of all, your home is not an investment.
Of course buying a home involves investing in property. But it’s not the same as purchasing a piece of real estate that can produce a steady monthly cash flow. If you want to get into real estate investing, you need to start pursuing opportunities beyond your own home.
That said, residential real estate primarily consists of single-family and multi-unit homes where other people live. This may include standalone homes as well as condos and duplexes.
Learn more: Buying a Duplex
How to invest in residential real estate
When investing in residential real estate, you purchase a property with the intent to either flip it or rent it out.
Flipping involves buying homes at discount prices and selling them at higher prices for a net gain.
Flipping a home can be risky. But if you do it the right way at the right time, you could potentially double or even triple your investment.
House flipping requires expert knowledge of the local real estate market. It also helps to have a great team of contractors on standby.
Learn more: Best Books on Flipping Houses
Another option is to buy a house and then rent it to short-term or long-term tenants.
Rental properties can be a great way to produce passive monthly income, and they can unlock attractive tax advantages for investors.
Buy residential REITs
Some real estate investment trusts (REITs) are specifically designed for the residential market, meaning you can buy funds that track residential properties (for example, $EQR).
This is another great way to produce passive income from residential properties in a fairly low-risk manner.
Buy tax liens
One of the riskier methods of residential real estate investing involves buying tax liens when property owners stop paying their taxes.
Buying tax liens requires paying the tax debt and penalties to the state or municipality and then receiving payments, plus interest, when those debts are settled.
Tax liens either expire once the property owner pays off the debt, or they enable investors to claim ownership of the property at a certain date.
Comparing commercial vs residential real estate
Have you decided whether you want to invest in commercial or residential real estate? Here are some things to keep in mind as you narrow down your options.
How easy is it to start investing?
Commercial real estate used to be a lot harder to get into because you had to be an accredited investor. Fortunately, this is no longer the case (although certain properties are still only available to accredited investors).
By and large, investing in the commercial real estate market is now easier thanks to a collection of third-party agencies, funds, and lending opportunities.
At the same time, residential real estate is generally much more accessible to the average investor because you don’t have to be accredited to buy residential property. There are residential opportunities for investors of all types — from high earners to people who are just getting started.
There are also plenty of REITs to choose from if you want the benefits of passive investing without the pressure of maintaining the property and dealing with tenants.
How risky is the investment?
Risk can vary significantly depending on the type of property that you’re investing in.
Funds, like REITs, tend to be the lowest risk for investors because they offer access to a diverse range of properties. Residential properties are also fairly low-risk, but they can still be a significant burden for investors depending on the house’s condition, location, and economic factors.
As for commercial properties, the level of risk largely depends on which sector you’re investing in. For example, buying a retail storefront typically has a higher turnover rate than buying an industrial facility. At the same time, the operational risks tend to be less significant.
If you’re thinking about investing in real estate, you need to determine your appetite for risk and allocate your funds accordingly.
Do you want to deal with property upkeep?
Most investment property owners don’t choose to participate directly in maintenance and upkeep. Rather, owners tend to outsource these tasks to third-party property management companies.
The amount of time and money you spend on maintenance and upkeep depends on your property’s size and the arrangements you make with tenants.
Some landlords choose to offer lower rates in exchange for tenants taking on certain maintenance requirements (such as mowing the lawn or taking out the trash in an office building). There is also a triple net lease option where you don’t have to pay maintenance expenses.
Don’t feel like you have to be tied to every responsibility when investing in a property. As a landlord, you may be able to factor these considerations into rental agreements.
What’s the return on investment (ROI)?
Again, it all depends on the specific property. And in some cases, the differences can be surprising.
For example, investing in a small residential property in a high-demand area could make you a fortune over time by renting it to vacationers — especially if it has low upkeep requirements.
At the same time, buying an expensive piece of commercial property in the heart of the city could wind up costing you a lot of money if you have trouble finding tenants or if extensive repairs are required.
If you’re looking purely for a steady cash return, you may want to consider putting your money into real estate investment trusts and sparing yourself the hassle of dealing with actual properties.
Tips for investing in real estate
Get a great real estate agent
Whether you’re making a commercial or residential investment, you’re going to need a first-class agent to help identify solid properties and provide guidance. The real estate agent you select will play a critical role in helping you make money on your commercial and residential leases.
Even investors with years of experience rely on agents to help make the process of finding and closing deals easier.
Sure, you’ll wind up paying a lot of money in fees to a good real estate agent. But it’s typically worth every penny, especially when dealing with commercial properties.
Location is key
Location is critical in real estate, making it even more important in both residential and real estate investing.
That said, sometimes, the best locations may not be apparent at first. Success requires looking ahead and understanding how markets are changing and neighborhoods are trending.
Frequently asked questions
What is the difference between rent and a commercial lease?
A commercial lease is a contract between a business owner and landlord that lasts for a specific period of time (like one year, five years, or 20 years, depending on the lease terms). Tenants simply pay rent each month to satisfy the terms of their lease.
What is a commercial building?
A commercial building is a type of property that’s used exclusively for commercial tenants. It may include retail buildings, warehouses, industrial centers, or even certain residential properties like apartment complexes or condos.
Is investing in a single-family home better than a multi-family home?
For real estate investors, a single-family home can be easier to manage because it comes with less maintenance and you’re only dealing with one residential tenant. Smaller homes may also come with a smaller mortgage and less expensive insurance premiums.
That said, multi-family homes typically have a better return on investment because they have multiple families paying rent.
If you’re getting rental income from three families, you may be able to pay down the mortgage three times as fast, leading to more robust profit over time.
It all depends on whether you’re trying to minimize costs or maximize profits. The home’s quality and location, the purchase price, and property taxes all play a huge role in determining whether a property investment is worthwhile.
Do commercial investors make a lot of money?
Commercial investors can potentially make a lot of money by making smart investments and claiming tax benefits.
Over time, it’s possible to earn a substantial amount through recurring monthly rent payments.
But there is no guarantee in commercial real estate. Market values could plummet from an economic downturn or changing market conditions, affecting the property value and the amount a commercial tenant is willing to pay for space.
If that happens and you own a commercial loan, you’ll be legally liable for repayment regardless of the economic climate.
The Bottom Line
It can be tough trying to decide between investing in commercial and residential real estate — but the good news is that you don’t have to.
New investors often choose to put their money into both commercial and residential opportunities by investing in REITs.
If you want to take a more active role in real estate investing, your best bet is to explore the market and come up with a plan that matches your needs and interests. As you move forward and assess your options, you may find residential real estate easier to understand and more appealing than commercial real estate — or vice versa.
Finally, remember that the best investment opportunities might require connecting with someone who knows the ins and outs of the market you’re thinking about pumping money into. By partnering with the right agent, you can potentially get wind of lucrative real estate properties before others do — making it that much easier to build your real estate empire.