Many real estate investors know significant differences between buying a residential property and a commercial one. Both types of investment can be profitable if you do your research and choose the right investment strategy. But they also come with their own set of advantages and disadvantages that make them better or worse choices depending on your needs as an investor. 

This article will explore the key differences between residential and commercial properties so that you can make an informed decision when considering which property type to invest in next.

Defining Commercial Real Estate and Residential Real Estate

Commercial real estate is generally defined as any property used for commercial purposes. It includes office space, industrial buildings, retail space, storage facilities, apartments, hotels, and warehouses. 

Commercial real estate is usually rented out by its owners to tenants who have business relationships. It can be a leasing agreement where the tenant pays rent monthly or an ownership agreement where the tenant buys the building.

Related: Commercial Real Estate Syndication: A Helpful Guide to New Investors

Residential real estate is any property that is used for residential purposes. It includes single-family homes, condominiums, townhouses, multifamily properties like duplexes or triplexes, mobile homes and trailers, apartments in high-rise buildings as well as apartments in low-rise buildings. 

Residential real estate is usually bought by its owners but sometimes sold through leases where tenants pay monthly rent.

Commercial and residential rates vary depending on local market conditions.

Commercial properties are inherently riskier investments than homes or apartment buildings. They are usually much larger and more complex assets that are harder for lenders to accurately value and price. 

Lenders must consider several factors when deciding whether you’re a reasonable risk for the loan. They’ll look at your credit score, income history, cash on hand, and other debts you may carry before deciding if they want to lend you their money. 

Commercial rates also vary more widely depending on local market conditions than residential rates do: lower-priced markets tend to have higher commercial rates than higher-priced ones. In comparison, higher-priced markets tend to have lower residential rates than lower-priced ones.

Commercial loans are more expensive than residential loans. Commercial property is typically used as collateral or collateralized loan, and the lender will require a higher down payment to offset the risk of default. Commercial property can be more difficult to purchase because it requires approval from multiple parties, such as property owners, tenants, and co-owners.

Commercial Real Estate interest rates are usually lower than residential interest rates but still much higher than investment-grade or high-yield corporate bonds.

Commercial properties generally serve as collateral for more significant amounts of debt versus owner-occupied single-family homes, where most people live in their homes free-and-clear after purchasing it outright with cash on hand or by taking out a mortgage based upon their credit rating at the time they applied for their home loan from a bank or other financial institution. 

There are no tax deductions for owning a commercial building, and the loan requirements are much stricter.

Residential real estate offers potentially higher returns but comes with a higher risk.

Commercial real estate investment is more stable and less risky, but residential investments have potentially higher and better returns. However, residential properties have more liquidity than commercial properties do. 

Suppose you need cash for an emergency or investment opportunity. In that case, it will be easier and cheaper to get money out of the residential property than it would be from a commercial one. Residential real estate is more volatile than commercial real estate. 

Residential property has the potential to appreciate or depreciate significantly in value over short periods, while commercial properties tend to be more stable. It is because a residential property has a higher percentage of its value tied up in land. In contrast, commercial properties have more value tied up in building improvements, and other assets are less susceptible to rapid changes in value. 

Residential properties will see depreciation or loss of value during economic downturns, such as an economic recession. Still, they are more likely than commercial properties to experience appreciation when markets are upward.

Commercial real estate can be more expensive than residential.

Commercial real estate can be more expensive than residential homes because of its higher property value. Commercial properties tend to have higher market values, meaning they’re worth more money. 

There are shopping malls and office buildings in large cities with high population densities and significant tourist populations.

Additionally, commercial properties often have higher property taxes than residential properties do. It is especially true in cities that charge an additional tax on businesses within the city limits instead of those who use its services. 

Business owners also face higher maintenance costs for their premises because of the longer lifespans of commercial buildings. 

If you’re operating a restaurant or retail store, you might need employees who earn more than someone working at a similar store in another business district could afford, so your payroll costs will go up. 

The property taxes as maintenance costs are higher than in residential homes because of the longer lifespans of commercial buildings.

Commercial buildings often have longer lease terms than residential homes, which can provide investors with long-term stability.

When investing in commercial property, you typically have longer lease terms than residential homes. 

It means you can have more stability and a positive cash flow over time. With longer terms of commercial leases, it is possible to build equity and increase the value of your investment. 

You can also make significant changes to the property, such as adding a new tenant or renovating an existing one. It provides investors with excellent stability over their holdings and long-term growth opportunities.

Triple net leases are an excellent option for commercial building owners. They allow the owner to pass on their maintenance costs and property taxes to tenants, so the owner can focus on maintaining the building instead of worrying about whether there’s enough money to pay bills. 

This system is also suitable for tenants because it allows them to concentrate on their business without having to worry about overhead costs like electricity, water, and other maintenance expenses, including property taxes, insurance, garbage disposal, snow removal, lawn care, etc. and any costs associated with repairs or improvements to the building.

The benefit of this arrangement is that it simplifies budgeting and accounting processes for both parties involved. Because tenants do not have to pay out-of-pocket expenses associated with operating their business space, they only need to cover their own rent payments every month. This makes it easier for them to predict their future financial obligations and plan accordingly.

Residential real estate investments are more familiar and easier to find and understand than commercial properties.

Residential real estate is more familiar to us, as it’s what we live in daily. We can easily picture a residential area with houses, condos, or apartments instead of an office building or commercial spaces. 

As a result, finding residential properties is simpler because you can have an easier time getting familiar with them and forming an opinion on their value. 

There are many more residential listings available in the MLS, online, and on social media platforms like Facebook and Craiglist than commercial listings, which tend to be harder to find.  

You may receive depreciation tax benefits if you invest in residential real estate than commercial real estate.

Depreciation tax benefits are one of the most practical aspects of residential real estate investing. Every time you purchase a new property, you may receive a depreciation tax benefit that allows you to deduct the cost of your home from your taxable income. It means that the government pays part of your expenses. 

You’ll have to pay taxes on this amount when it comes time to sell or refinance, but until then, enjoy it.

Although commercial real estate investments are profitable and have many advantages over residential properties such as higher potential returns, they do not offer depreciation tax benefits unless used for rental purposes and leased out for more than 50% of their total usage (i.e., if a store uses 40% of its space for storage). 

Suppose a commercial building is used solely for business purposes and not rented out. In that case, there will be no provisions made by government agencies concerning any possible deductions related directly back into their own pockets via reduced taxes paid during those years they weren’t occupied or utilized at all.

The tax code allows investors who purchase residential properties up to $1 million and file an election form with the IRS to depreciate those properties over 27.5 years. 

The depreciation rate is 1% of the adjusted basis each year until it reaches 50%. Investors who own commercial properties are limited to a straight-line method over 39 years with no additional benefit.

Multifamily homes offer flexibility and stability not found in the market for single-family residences. 

Multifamily homes offer flexibility and stability not found in the market for single-family residences. Multifamily homes are often larger than single-family homes and can be rented out to multiple tenants. 

It makes them more stable than their single-family counterparts. You won’t have to worry about your tenants moving out at once or emptying the entire building like you would with a single-family home. 

When you own an apartment building, your tenants become your responsibility. If one moves out, you can easily find another suitable tenant without dealing with the hassle of selling your property in today’s competitive real estate market. The excellent news, multifamily properties have lower vacancy rates than other housing types. 

Related: Multifamily Real Estate Investments: Easy Guide to New Investors

Multifamily units are built closer together and have shared amenities, including washers/dryers and workout rooms. These factors encourage residents to stay on the property rather than instantly move out when maintenance issues arise. 

Also, in terms of preferences, many people prefer to rent a property where they and their families feel safe and secure when living in a convenient and welcoming residential community, especially if they have easy access to private schools, shopping centers, etc. Often, it’s this combination that attracts investors to multifamily properties.

In addition, there are some tax benefits associated with owning a multifamily property as well. However, there may be restrictions depending on where you live, so it is advisable to check with your accountant. 

Most states allow landlords who own multiple units within one building, such as duplexes, to avoid paying property taxes based on assessed value by instead paying taxes based on income received from said units’ occupants each year. It means less paperwork.

It doesn’t mean that owning a multi-unit building will automatically make money. Some parts of town will always fetch higher rents while others might require significant repairs before they’re ready for renters again, but if done correctly, it could mean high rental income.

You can be a real estate passive investor and gain good returns without spending much time on the leg work. If you’re interested in multifamily real estate passive investment and need help figuring out where to start, get the free copy of Wellthy Capital‘s E-book and gain valuable insights into multifamily investing and wealth-building by listening to podcast The Path to Wellth with Hannes Hennche. 

Recommended Video:  How to Get Into Multifamily Investment: Tips to New Investors

Every type of real estate investment has its strengths and weaknesses, but they both have the potential to generate cash flow to grow your investment portfolio.

Real estate investors make money through rental income, appreciation, and profits generated by business activities that depend on the property. To make money as a real estate investor, you need to find properties that will appreciate in value over time. 

If you’re buying a property for rent, it’s essential to look at its value as it relates to its income potential. If you’re buying a property for investment purposes, look at how much money it will make when rented out or used for business activity.

The first thing an investor should do is compare the asking price with the prices of similar properties. You’ll want to look at comparable sales data from recent transactions and current listings on the market to get an idea of what similar properties are selling for now versus what they sold for previously. You should also consider looking at recent appraisals if available.

 These can give you an idea of what similar properties are selling for now versus what they sold for previously or may have been appraised for.

You’ll also want to consider factors like location and condition when determining whether or not a particular property fits within your financial goals and objectives. You will find that every type of investment has its ups and downs. However, they have the potential to generate cash flow and are a better choice of assets to grow your investment portfolio.

Conclusion

We hope this article has helped you understand the differences between residential and commercial real estate. Real estate investment has a lot of benefits. It allows you to grow your portfolio and generate cash flow while providing an excellent hedge against inflation. 

Finding the correct type of property for your needs is key to making a real estate investment success. It’s important to remember that if you plan to invest in these asset classes over time, it‘s a great way to diversify across different types of properties so that your portfolio remains balanced in the long run.

Recommended Video: The Secrets of Real Estate Tycoon with 15,000+ Apartments