Thinking of investing in commercial property? Read this first. If you’re looking to invest in real estate, it’s important to understand exactly what you’re getting into.
Any type of property – whether commercial or residential – can be a lucrative investment, but they also come with a certain set of risks. So, if you’re looking to break into commercial real estate investment, you should know this is not a leap to take blindly. In fact, the debate on whether investing in commercial property is better than residential property continues to divide investors.
The Difference Between Residential and Commercial Property
There is a general perception among beginner investors that investing in commercial property is meant only for business class or big investors. This is not always true. Commercial properties may refer to retail, office, and industrial buildings, in addition to warehouses and “mixed-use” buildings. A residential investment property, on the other hand, is one that provides accommodation for tenants to live in (used for non-commercial purposes). They include single-family homes, multi-family homes, townhomes, condos, apartments, and vacation homes.
Note: To start looking for and analyzing the best residential investment properties in your city and neighborhood of choice, click here.
Both types of investment properties have the potential to generate rental income, positive cash flow, and make profits from resale. But, which is the better investment strategy: investing in commercial property or residential property? If you’re a beginner property investor, real estate experts advise you to go for residential properties. Here are the main reasons why.
1) Higher Risks and Vulnerability to External Factors
Although investing in commercial property appears to be the more lucrative option, beginner investors should know that with higher returns come higher risk. In addition, commercial investment properties are sensitive to economic conditions. This means the profitability of commercial properties is linked to the performance of the real estate market’s economy. When the economy is strong, the job market grows and demand for commercial real estate rises. On the other hand, an economic downturn will reduce the demand.
Changes in infrastructure and supply of properties can also affect commercial investments. If there’s an increase in new properties coming on the market in your area, it’ll create more competition for you. What’s more is that if this increase was in surrounding areas, it can threaten your occupancy rate as it can lure tenants away from you and, as a result, reduce your potential yields.
Though economic conditions can also impact residential real estate investors, the impact is more severe for those investing in commercial property. Moreover, people will always want homes to buy and rent. Thus, there’ll always be demand for residential properties in any real estate market.
2) Investing in Commercial Property Requires Bigger Initial Investment
Another major difference between residential and commercial property is with regards to financing the investment. Commercial properties will typically require more capital up-front than a residential property for sale. If you’re planning on taking out a loan to finance a commercial investment property, you need to pool more money from your pocket for a down payment larger than 20%. Interest rates for commercial properties are also 1.5% – 5% higher than for residential properties. This can make it more difficult to break into the commercial real estate market.
Moreover, once you start investing in commercial property, expect more pocket expenses to follow throughout the course of property ownership. Besides your initial capital, you’ll need to cover insurance, maintenance costs, repairs, facilities, advertising the rental property when there’s a vacancy, and more. As you can see, commercial real estate investors have greater liabilities. If you don’t have tolerance for risk, it’s best to consider putting your money in a residential real estate investment.
3) Not Easy to Find Tenants / Resale
One reason that might draw you to investing in commercial property is that it attracts long-term tenants. However, while this is true, finding such a tenant actually takes longer. In fact, it’s very common for commercial real estate properties to have a higher vacancy rate. This brings yet another risk to this type of property because you, the real estate investor, will have to cover all the costs during the vacancy period until you find a new tenant.
Not only that but, compared with residential real estate investments, commercial properties are not easy to sell – you may not even find many buyers. As for residential real estate investments, these are much easier to resell and find tenants for seeing that, as mentioned, there’s always demand for them. Finding residential property for sale is also much easier, especially with a property finder tool like the one we offer.
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4) You Need Professional Help When Investing in Commercial Property
Another reason why real estate experts advise beginner investors to invest in residential properties is that they’re easier to manage. With commercial investment properties, there’s a high chance you’re not ready or even able to handle maintaining and managing the property on your own and you’ll need to hire a company or a professional property manager to help you. While this could benefit you by reducing your responsibilities, it’s not easy to find a qualified property management company.
In addition, these companies typically charge between 5-10% of your rental income for their services. This creates an added cost to the list of expenses your rental income needs to cover. Is this ideal for a beginner investing in commercial property? Definitely not. Residential real estate investors, however, manage their rental properties on their own all the time. This becomes especially easier if you’re investing in a single-family home near you.
Are you looking for a residential rental property for sale near you? Use our data and analytics to identify the best one. With our Rental Property Calculator, you can estimate the potential rental income, cash flow, cash on cash return, and cap rate of rental properties in any city/neighborhood in the US housing market! To learn more about our investment tool, read “Mashvisor’s Rental Property Calculator: A Guide for Beginner Real Estate Investors.”
The Bottom Line
As you can see, you need to go back and forth comparing your options to understand the difference between residential and commercial property and make the right investment decision. Investing in commercial property generally suits those with more real estate investing experience and more capital. When you’re a beginner investor, you may not be able to take on the risks of such an investment. This is why real estate experts advise you to stick with residential rental properties. Don’t take this as a negative thing – quite the opposite; many successful property investors made their fortune with residential real estate investments!
Searching for a residential property for sale? Click here to start looking for, analyzing, and comparing the best investment properties in your city and neighborhood of choice. To get your hands on the best investment tools our platform has to offer, sign up with Mashvisor or click here to start your 14-day free trial with Mashvisor and subscribe to our services with a 20% discount after.