There are a few main reasons you might want to compare commercial versus residential real estate. One of the big ones is if you’re thinking about investing. You might also be considering a career in real estate, or you could have experience with either one, but you want to learn more about the other.
The technical distinction between residential and commercial property is that residential real estate is single-family homes or rental residences with anywhere from one to four units. Commercial property is usually considered anything with five or more units.
A condo, duplex, or quadruplex falls under the umbrella of residential real estate. Multifamily properties with five or more units, offices, retail spaces, industrial spaces, hotels, and special-purpose buildings are categorized as commercial real estate.
Along with the property differences, there are distinctions in the tenants each attracts. Residential property is usually leased to an individual or a family. Commercial properties are frequently leased to businesses.
As far as investing, commercial real estate often awards investors a wider range of possible investments. For example, there are more commercial investment funds than residential ones. By contrast, residential real estate investing allows investors to take on a more active role.
Residential Real Estate
Along with the types of properties listed above, other property types categorized as residential include townhomes, cooperatives, triplexes, and mobile homes. A mixed-use property can be a combination of residential and commercial real estate.
If you invest in residential real estate, possible upsides include:
- There’s a low barrier to entry. There’s no major learning curve that comes with investing in residential real estate, and you can find this type of real estate nearly anywhere.
- While there are ups and downs, residential real estate generally has a big pool of buyers, sellers, and renters. That doesn’t mean there aren’t downturns, but everyone needs somewhere to live, even when the economy isn’t strong.
- It’s easier to finance residential real estate, and various sources like conventional loans, VA loans, and FHA loans can be used.
- If you’re a landlord and you have a residential property, the lease terms are typically only a year, so you have the chance to change the rent terms accordingly, depending on market conditions.
- Residential properties require maintenance but are almost always easier than commercial properties to manage overall.
- If you invest in residential property and you want to sell it, you have a lot of options available to you.
The downsides of investing in residential real estate include:
- If you want to rent out a residential property, there’s more potential for vacancy. There are fewer units, so you may have higher vacancy rates if it takes longer than usual to find a qualified tenant. If a tenant moves out of your residential investment property, you have a 100% vacancy rate until you find a new renter.
- While the maintenance might be simpler for residential properties, landlords have more responsibilities for maintaining residential properties.
- It can be harder to evict someone from a residential property because fair housing and landlord-tenant laws must be followed.
- Residential real estate is a competitive market, and it can be harder to find properties to buy.
Commercial Real Estate
The term commercial refers to places where people are doing business. Commercial property can be owner-occupied or rented to tenants, as is the case with shopping centers. Categories of commercial real estate include industrial, office, retail, warehouse, and hospitality. Commercial real estate can also include student housing, resorts, government buildings, and religious facilities, although these are technically special-use properties.
If you invest in commercial real estate, benefits can include:
- Potentially higher returns. If you’re taking more risk, which you are usually with commercial investing, you will have the potential to make more.
- It may be easier to find qualified tenants because commercial renters are usually businesses, and a larger company often backs corporations.
- There are triple net leases, which can vary in specifics, but usually, a property owner doesn’t have to pay property expenses with triple net leases. The lessee handles the expenses directly.
- The lease terms are often longer compared to a residential lease. A commercial property might lease for five to ten years, with lower vacancy rates and turnover costs.
- Commercial real estate is impacted directly by its revenue, so the more cash flow a commercial property earns, the higher the property value. You could see a more significant increase in value with commercial real estate in a shorter time than with residential properties.
The downsides of commercial real estate include:
- There is a higher barrier to entry than residential because commercial real estate is more expensive.
- It’s tougher to finance commercial real estate because a lender often sees a commercial loan as riskier.
- You won’t usually self-manage if you own a commercial property because specialized management is needed.
- There aren’t as many exit strategies available.
Finally, during economic downturns, the demand for commercial real estate also tends to decrease. Business tenants will usually focus on trying to save money, which means scaling back, or they might go out of business altogether.