Should I Invest In Commercial Real Estate or Residential Real Estate?
Should I Invest In Commercial Real Estate or Residential Real Estate?
Updated on July 15, 2020
In the real estate investing world, you have two core options: commercial real estate and residential real estate. Which one you should invest in is a long-debated topic that we could spend a lot of time on, but we’ll touch on the general pros and cons to consider as you are becoming a real estate investor.
Residential Real Estate Investing: Pros and Cons
The majority of investors start with a residential investment in a single-family home. Let’s consider the pros of residential properties:
It does not take as much capital to get started. You can “get in the game” and get a rental property with a relatively small down payment.
You are not managing multiple tenants. No crazy lease terms, no property manager to manage (if you so choose). Your real estate investment can be set up and self-managed relatively easily.
You do not need an in-depth investment strategy. There are a lot of opportunities for rental income that can generally make sense as long as the purchase price is attractive relative to the NOI that can be achieved.
You have an easier time selling the property. You can sell this to anyone in the market for a home, not just investors and companies. If and when the time to sell comes, it should be easier to “convert to cash” if you need to.
Now a look at some of the cons of a residential investment property
When it is vacant, the property owners have zero cash flow. Commercial properties are typically multi-tenanted or have a high credit single tenant with a long lease in place. The vacancy rates are less of an issue. In a single-family home, until you have renters, you have no income.
Turns kill profits. Every time a renter moves out and the house needs to be “turned” which is to make it ready for the next tenant, it costs you money. It’s very easy to lose a year (or more!) of profit every time a tenant moves out. This is the main reason that tenant selection is so important.
The process to get a single-family home can be just as long as the process to get an apartment building. Smaller and less expensive does not equate to faster and easier.
Upkeep – you have capital expenditures that will need taking care of (Roof, windows, heater, etc.). These can eat into your net operating income as years go by. You have these as well in a commercial property, but specific leases can specify that certain responsibilities be taken care of by the commercial tenant.
Commercial Real Estate Investing: Pros and Cons
Earning potential – You are buying at scale with commercial property, and you receive economies of scale because of that, making your earning potential higher than that of residential. With various commercial leases such as a triple net lease, you can also set yourself up for less risk and less maintenance costs.
Scalability. You can make one purchase and have 300 units in a multifamily apartment complex giving you 300 sources of monthly rent. How long would it take to buy 300 houses? With a few purchases, you can have a robust portfolio of commercial buildings that are giving you a significant return on investment
Variety. Raw land, shopping centers, apartment complexes, office buildings and industrial parks; there are plenty of options in the commercial space. They each have various models that have tried and true paths to great returns when well executed.
Property management. With larger properties, they are more management intensive, but with the larger cash flow that comes with a larger property, you have the opportunity to bring on professional property management that understands how to operate at a more efficient level.
Now let’s look at some of the cons of commercial property
It has a larger initial investment. It’s going to take considerably more money to purchase a shopping center than a 3 bedroom house. Commercial real estate investment in any real estate market is not cheap
It takes a team. This is only listed under the “con” section because most people reading this who are asking the questions of “which should I invest in” will be individual investors. A lot of people thrive in a team environment and you can go further with a team, but it takes time to build a great team.
More Risk. There is a lot more activity at a commercial space than a residential property, which opens up the potential for more damage to happen and for people to get hurt.
Time. You’ll more than likely be spending more time with your commercial investment to make sure that it is performing. Between the additional tenants, team and general responsibility needed to the upkeep of the property, it will be more of a full-time job than a few single-family houses would be.
What do we think?
The bottom line is that both avenues can be very lucrative. It depends on your goals and what level of involvement you want in the business. The most natural path that we see is a lot of people cutting their teeth in residential and eventually moving on to the commercial sector if they decide to continue buying real estate properties throughout their careers. Of course, we’re biased toward commercial real estate as that is what works best for our firm and our investors. We don’t discount residential investing at all. It’s really all about what you find works best for you as an investor.
A lot of our passive investors in our shopping centers were single-family home landlords who found they just didn’t like the business of being a landlord after years of owning. If you would ever like to know more about the profit potential and tax benefits from being a limited partner in a passive investment commercial real estate opportunity, please reach out to someone on the team at First National Realty Partners. We would be happy to help.
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