The real estate market is one of the most reliable investments and has made 90% of the world’s millionaires. If you’re looking to venture into the industry, you’ll have to decide between investing in residential or commercial property.
Each of these options has profit potential. But depending on your goals and financial well-being, one option will be more suitable than the other.
Before you decide, you need to understand the commercial property vs. residential property differences. Read on to learn how the two types of real estate differ and the pros and cons of investing in each.
What Is Residential Property?
Residential property is any type of land or building used for living purposes.
Residential property categories include:
- Single-family homes
- Multi-family homes such as duplexes, triplexes, and quadplexes
- Mobile homes
Residential property can be further divided into two types:
Primary residences: These are the homes people live in full-time.
Secondary residences: These are vacation homes or investment properties that aren’t lived in full-time.
Pros of Residential Property
One advantage of residential properties is that you don’t need a lot of money to get started. You can finance your purchase with a mortgage and only come up with a small down payment.
The properties also have stable demand. The world’s population is ever-growing, and there will always be a demand for shelter.
You should buy a residential property in an area with high growth potential. This way, you’ll always be assured of having tenants.
Compared to commercial properties, residential properties are much easier to manage. If you don’t have time, you can find a property management company to take care of your rentals.
Cons of Residential Property
The average return on investment (ROI) for residential property is lower than commercial property. This is because there’s more competition in the market, and you’re competing with people buying homes to live in.
Finding tenants willing to pay top-dollar rent can be challenging, especially if your area has many vacant units.
What Is Commercial Property?
Commercial property is any type of land or building that people use for business purposes.
Some categories of commercial real estate include:
- Office spaces
- Retail stores
- Industrial spaces
- Hospitality such as hotels, motels, and restaurants
Commercial property can also be classified as:
Class A: These are the newest, most luxurious, and well-maintained properties. They’re usually in prime locations.
Class B: These are older properties that may not have the same amenities or be in the same location as Class A properties, but they’re still in good condition.
Class C: These are the oldest properties that are in need of repair. They’re usually in less desirable locations.
The Pros of Commercial Property
Investing in commercial property will guarantee you a higher ROI. The commercial real estate market isn’t as saturated as the residential market. This means there’s less competition, and you can charge higher rents.
Commercial tenants are usually businesses that have been around for years and are doing well financially. They can afford to pay you high rents, and they’re less likely to default on their leases.
You’re also more likely to get longer lease terms from commercial tenants. This gives you stability and predictability, as you don’t have to worry about finding new tenants every year.
Cons of Commercial Property
You’ll need a higher initial cost to buy a commercial property than a residential one.
Investing in commercial property is a long-term commitment. The average commercial lease length is three to five years, and it can take years to sell a commercial property. This might be a problem if you want to sell the property soon.
You also have to be prepared for volatility in the commercial property market. You may also have a hard time finding tenants during a recession.
For residential properties, your customers will be tenants who will pay a fixed monthly rent for the time they’ll stay in your property. For commercial properties, your customers will be companies and business owners looking for a space to operate their business.
It’s more challenging to retain tenants in a commercial property. When the business isn’t doing well, they will change offices.
On the contrary, residential tenants are likely to stick around for longer. If you do a thorough tenant screening, you’ll find individuals or families willing to stay at your premises for a longer-term.
Tenants will use your residential properties all the time. As such, they’re more subject to wear and tear. You’ll have to deal with simple, regular maintenance either yourself or with the help of a property manager.
For commercial property, maintenance is more complex because of its size. Any commercial property guide will tell you to hire full-time property managers to keep your property in good shape.
Renting or Leasing Contract
You’ll need a rental property lease agreement for all your residential real estate tenants. The contract should stipulate the terms for the tenancy period.
You can write the rental agreement yourself if you know what to include. The rental contract covers a short period, and you can change it.
However, the lease agreement for commercial property is complex and covers a longer term. You can not alter the contract as you wish. You can choose a net lease so that the occupant covers property taxes, maintenance, and insurance.
You’ll have more freedom to modify the residential property. You can change the design and the layout.
You won’t enjoy such freedom if you invest in commercial property. If you need to change anything, you’ll need a legal team to help you overcome the hurdles of designing the building to your satisfaction.
Understand the Commercial Property vs. Residential Property Basics
If you have a commercial property vs. residential property debate, our article has the details you need to understand the differences. You’ll have a better understanding of these two types of real estate if you read through the pros and cons of each.
And if you’re still unsure which option is right for you, our team at Reedy & Company can help you. We have specialists who will provide best-in-class advice to help you make the best property decisions. Contact us today to learn more about our services.