Real estate investing can be difficult to understand for those who are new to it. What type of good to invest in? Which region of the country performs the best? Are Commercial Properties More Profitable Than Residential Properties? Investors need answers to these questions so that they can make informed decisions about where to use their hard-earned capital.
What is commercial real estate and residential real estate?
Commercial real estate is an umbrella term that encompasses important parts of the market such as retail businesses, offices, and industrial properties. These properties come in all shapes and sizes and include apartments, daycares, condominiums, cinemas, parking lots, industrial floors, warehouses and retail spaces occupied by brands like Big Bazaar, Croma and others.
In short, any property that can be used explicitly for commercial purposes can qualify as commercial real estate (CRE). Now there are also multipurpose spaces that can be used as commercial spaces and residential areas.
Residential real estate includes dwellings that are generally rented and not owner occupied. It may sound too simple, but in reality it is the same. Any property that is created solely for the purpose of living there is called residential real estate (RRE). They can also be part of multipurpose spaces as explained in the last section.
The main difference between RRE and CRE is in the way they are rented / rented, as well as in the associated legal aspects. Since these aspects are different, the aspect of investing in either of them is also very different while the underlying principle remains the same.
What is the difference between investing in commercial real estate and residential real estate?
Does an investment in commercial real estate make more sense than an investment in residential real estate? The answer to this question doesn’t have to be yes or no, but it’s worth exploring both options. It can work well if you are clear about your goal, the amount of money you need versus the investment income you desire, and your timeline for generating profits.
Real estate, according to the rule of thumb, is an asset that only generates good returns if it is held for a long time: two years or more. This also applies to RRE and CRE. As an investor, or rather a retail investor, RRE may seem easier to access than CRE and the former may seem to offer better choices for customizing your portfolio. To better understand what each investment avenue offers, let’s take a look at the main differences between the two and which one would best fit your bill.
When it comes to investing, you really have two options; invest in commercial or residential real estate. Most people will fight for a camp and be strong supporters of it. However, depending on your economic situation and what you are trying to accomplish, both may be valid options. Of course, you can invest in both with your own money, but renting a residential home is a lot more work than owning a commercial property if we think about maintenance and time spent communicating with tenants and the like.
As with any investment avenue, the objectives and the risks involved are the deciding factors in evaluating the effectiveness of an investment in commercial real estate compared to residential real estate. Let’s see some more details.
In terms of RRE:
- An investor must primarily buy a property and own the physical asset on its own. They can bring in family members as co-investors, but this is mostly where the partnership ends.
- You might miss interacting with seasoned investors when looking at residential real estate. In most cases, people primarily build their own properties and rent them out.
- The other uncommon option for being an investor is to sublet a property for a fixed lease term. In this way, the investor only obtains ownership of the property for a period of 5 years or more. There is no purchase involved, so after the rental period ends, if the investment has not performed well, the investor can easily switch to another asset.
- In any case, the uncertain nature of the tenants and the extremely short terms of the leases make the investment in the RRE less profitable. However, since there is less paperwork and investment, it is easier to get into this field.
At CRE level:
- Comparatively, CRE is even more difficult to integrate for an individual investor.
- The initial investment is quite large for a retail investor in most cases and one needs to have a good understanding of market demand and supply in order to properly assess the benefits of this investment.
- Here, however, a real estate investment company can come in handy. They can do all of the heavy lifting of the legal aspects and you can simply choose whether an investment option is right for you.
- With the addition of REITs and fractional ownership to the investment scenario involving real estate, it is now easier for a retail investor to get started with CRE investing.
- Both options reduce the size of the initial investment and offer hassle-free investment procedures aimed at long-term investments.
How to choose between commercial real estate and residential real estate?
As mentioned earlier, investing depends on two major factors on the investor’s side: the risk involved and the objectives sought. Investing in real estate also carries a risk of potential loss of the investment. If a property does not get enough tenants during the investment period, the returns would not justify the investment in question.
CRE Vs RRE
- In general, commercial real estate is less risky from this point of view as it almost always has a stable cash flow due to the strong lease terms in place for tenants. In contrast, acquiring a residential property can be quite risky as these tend to have unstable cash flow with the potential for drastic changes in market demand.
Residential real estate has been the hardest hit in the real estate segment during the start and spread of the pandemic. Moreover, any decline in economic activity in any region will affect residential tenants first, as they will always want to cut their losses in the absence of a concrete long-term lease contract.
- If you know a market well enough and have local contacts, it may make sense to invest in RRE for a relatively shorter period. For CRE, it is good to have long-term goals, at least five years or more. This way, the returns generated make more sense and the passive income actually frees you up time to consider other avenues of investment.
The advantage of commercial real estate is that rents tend to be more stable and lease terms are generally more concrete and long lasting, which means tenants are almost always available. Commercial properties tend to generate more gross income with less labor. Residential properties offer better returns in most parts of the country and do not require a large down payment since there is no mortgage and tenants incur no interest charges.
Ultimately, it’s best to consider all of the options available before committing to investing in CRE or RRE.