Commercial vs Residential Real Estate: Pick the Best Investment for You
Both commercial and residential property investments require distinct approaches, so which one is right for you? We compare these markets to help you decide.
Are you trying to decide between residential and commercial property investment? The truth is, these two markets require different approaches, so one could be a better fit for you than the other.
To begin, we’ll briefly cover what each market entails and then get into the pros and cons. Continue reading to learn more.
What are the major differences between residential and commercial property?
Residential properties are homes or apartments. These might be single-family houses, townhouses, studios, etc. Most people who invest in residential property but don’t live in it themselves will rent it out to others, so they can generate income from the property. This introduces a very specific relationship between the owner, or landlord, and the tenants. This relationship is different from the one that exists between commercial landlords and tenants. This is because, in the case of residential property, the tenants live in the space, meaning the landlord plays a larger role in their personal lives.
Commercial property, on the other hand, is any property not primarily used as a residence: office spaces, retail spaces, warehouses, and even hotels. Commercial property owners may run a business out of their space, but investors in such properties usually lease them out to other businesses. Lots of companies would rather rent a space than buy one, to save their capital for investing in their own business. This means commercial property investment is supported by the work of other businesses. Simply put, successful businesses are better commercial tenants than unsuccessful ones, whereas this is not the case with residential tenants, who are more consistent.
Getting started in real estate
The first thing you need to do in either market is get invested, but this varies a little between residential and commercial properties. Conventionally, commercial property is considered more difficult to get started in. This comes down to one key point, which is the initial cost of investing. Not only do commercial properties tend to be more expensive—usually due to their size and potential returns—but banks tend to lend at lower Loan-to-Value ratios than they would for residential properties. This means that even though a bank will loan you a bigger sum for investing in commercial property, the sum will be a smaller percentage of the overall cost, leaving investors to put more of their capital into the property.
All this means it’s very important to do your homework when investing in commercial property. Of course, it’s vital to do background checks in residential property investment too! This might involve looking into titles, land covenants, or building inspections. Both residential and commercial property investments require these sorts of background checks, but there tends to be a few more specific checks when it comes to commercial real estate. Earthquake resistance, for example.
Building relationships with tenants
Commercial buildings are also often considered harder to invest in because there’s a possibility you’ll need to manage multiple tenants at a time. This isn’t the case with a residential property, where you will probably only have one group of people as tenants per property. A similar situation exists for many commercial retail spaces. For example, Investing in office space might mean you gain responsibility for multiple floors, with multiple tenants on each floor.
In both cases, property management is the best way to manage tenants. Property managers can keep track of larger groups of tenants much easier than a single landlord and can ensure that everyone is looked after. On the other hand, in smaller commercial settings or residential settings, landlords often feel that they can handle the tenants themselves. Sometimes this is true, but often it can lead to missed opportunities for getting the most out of the property, especially if a landlord has multiple residential properties to look after alone.
Return on investment
The reason that commercial property seems much more expensive to get into, yet remains a popular form of investment, is the higher return on investment. Residential tenants may change relatively frequently, but commercial tenants commonly sign much longer contracts—sometimes even decades-long. This ensures a steady income from the property, making it well worth investing in.
That’s not to say it’s not worth investing in residential property; it’s much easier to find tenants for housing than it is to find commercial tenants willing to sign a multi-year lease, and the core reason why is that people will always need somewhere to live. With residential property, there will always be demand. With commercial property, the return on investment can be much higher, but only if you have a good tenant. Therefore, it’s a great idea to invest in a commercial property that already has tenants, and it’s less advisable to invest in a vacant commercial property.
Still not sure which one is right for you?
Several other factors can come into play when choosing between residential and commercial property: the risk profile, the responsibilities of maintenance, etc. However, the bottom line is that a well-managed property can be successful, no matter which market it’s in. If you’re looking for residential or commercial property for sale, or you have a property in mind already and you want some more guidance on getting the most out of it, talk to us. Contact JLL now. As professional property managers, we’ll be happy to answer your questions.