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So, what’s the big difference between residential and commercial real estate? If you’ve considered investing in real estate as a means of supplementing your income — congratulations! There are many opportunities for success ahead of you if you plan accordingly and make wise choices. The first hard decision you’ll have to make as a real estate investor is what kind of property you want to invest in. Whether you choose residential or commercial real estate, you will see challenges and rewards.
Here’s a breakdown of some major ways that investing in commercial real estate differs from residential real estate. Let’s start by taking a look at what kind of property each one entails.
Residential real estate, which most people have rented at some point in their life, is an accommodation where the tenant lives. It can be a single-family home or a multifamily home up to four units (with five or more units, it becomes a commercial property). However, ownership of a condo or apartment unit is still residential as long as it is individually owned.
Commercial real estate refers not only to office buildings and complexes but also retail stores, restaurants, medical facilities, shopping centers, hotels and apartment buildings.
Here’s a little bit of what you can expect from investing in commercial real estate as opposed to residential real estate:
- Investing in a commercial property will likely have a higher return on investment than residential real estate, but it does typically have more risk. Commercial real estate will require more money upfront, and loans for commercial properties are typically paid off over the course of five to 20 years. Residential real estate properties are paid off over the course of 30 years.
- Because commercial properties are more expensive investments, those who are just starting off may be able to afford only one property. It’s risky to have all your money tied up in one place. A cautious investor often starts with residential real estate investing. It is not unusual for the average person to have the means to buy a second residential property (in addition to their own place of residence) that they can rent out. After doing that for a few years, possibly even with a few properties, they branch out to commercial real estate investing. This will allow the investor not only to save money but also to build experience.
- If you’re looking to make money in the short term, such as by buying a property in need of repair, renovating it and reselling it, then residential is your better option. Flipping residential properties as an investment is practical, whereas commercial properties are more valuable over a longer period of time. One of the reasons it can be difficult for an investor to procure a loan for a commercial property is that they have to show a business plan and demonstrate they will have dependable cash flow. This is not the case with residential real estate.
- That said, the market value of a commercial property is often determined by how much revenue it brings in. Unlike a residential property, which has a market value based on its amenities and location (e.g. two bedrooms, one bathroom, with proximity to the interstate), a commercial property could be more or less valuable depending on the company that rents it. Making practical improvements to your commercial property are important not simply because they will make the space more attractive to tenants but also because they will help the tenants succeed in business.
- However, be prepared to face greater challenges renovating or expanding a commercial property. Commercial real estate has stricter zoning laws, and you’ll likely have to deal with strict regulations and have to jump through some hoops to get the building permits you need.
- It’s also important to have the highest quality commercial property available for rent because, when it comes to commercial property, supply is higher and demand is lower (think of the number of times you see a vacant storefront). Residential real estate tends to be easier to rent out because there’s higher demand — people will always need a place to live even if there aren’t businesses looking for new space.
- The lending process is different for buying a residential property versus buying a commercial property. A residential loan takes place between a bank and an individual owner or owners. Because a commercial property is zoned for commercial use, its loan will be between the bank and the company or business. A representative of the business, such as the CEO or president, signs on behalf of the business.
- You’re going to be working with very different tenants when it comes to commercial real estate versus residential real estate. A business, which must maintain a good image, possibly meet health standards and keep its facility in good operating order will be more likely to take the best care of your property that it can. A residential renter could be hit or miss — if they aren’t responsible, they could take poor care of the property. You do face a risk of higher turnover in residential real estate, which can be detrimental. A long-term lease is better for either type of property because it offers you more reliable income and lower risk of vacancy; however, a business is more likely to choose a long-term lease than a residential renter.
These are only a few of the ways commercial real estate investing is different from residential. To learn more about whether commercial real estate investing is right for you, email info@murphycre.com.
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