Investing in real estate is a great way to add some diversity to your portfolio and spread the risk you’re exposed to. Even more, you can greatly benefit from the fact that the real estate investments have been historically been a solid investment that’s less susceptible to market swings. Plus, you can utilize leverage when investing in real estate, where a relatively small cash outlay lets you control a large total investment.
In general, real estate investments can be broadly categorized into two: residential and commercial property. Each has its own benefits and drawbacks. And if you’re new to real estate investing, it’s important to know how they differ.
Commercial Real Estate
Also known as income property, commercial real estate is the land or buildings that are put up with the intention of generating a profit. Much of the commercial real estate is retail space, office buildings, warehouses, raw land, as well as industrial type buildings. For instance, a piece of land can be bought and then sold to a developer at a profit. An office building generates rental income from the tenants. Due to the capital requirements, investing in commercial real estate mostly attracts people with a lot of money and business education and/or experience.
One of the outstanding upsides of investing in commercial real estate is the earning potential it offers. For instance, if you invest in developing an office space in a city where square footage is charged a premium, you’ll be in a position to charge high rates. This is true provided the demand stays high and your operating expenses remain reasonable.
However, a steady cash flow won’t come without a price. Keep in mind that managing a typical commercial property isn’t a one-man thing. You’ll most likely need to get a professional property manager to look for and vet tenants, oversee the daily operations, and coordinate the leasing agreements. You’ll also need to pay for maintenance and upkeep. Sometimes, these costs could add up and lower the amount of revenue the property is generating.
Moreover, unless you’re investing through a crowdfunding program or buying shares in a REIT (real estate investment trust), commercial property investing requires a larger upfront payment compared to residential property.
Residential Real Estate
This encompasses all the single-family homes, cooperative units, condominiums, as well as the one-to-four family rental residences. Most people invest in the residential real estate space by purchasing homes or similar rental properties and becoming house flippers or landlords. Flipping a house entails buying a house at a relatively low price, fixing it up a bit, and then selling it at a higher price.
Investing in residential properties won’t be as stressful as investing in commercial real estate. Rather than having to manage multiple tenants, you’ll only be dealing with one or a few. The ongoing maintenance costs will not be as high, especially if you invest in a single-family home. And if you do decide to follow the fix and flip route, you won’t have to worry about looking for and vetting tenants.
Furthermore, since you don’t need as much money to get started, entering the residential real estate space will be much easier. For instance, those trying their hand at house flipping can easily secure a short-term loan and pay just a little amount out of pocket (at least the first time you take out the loan). However, since these loans usually let you pay interest-only contributions, then you need to be sure that you can sell the house quickly to avoid being stuck with a balloon payment.
Nonetheless, there are a few drawbacks when it comes to investing in residential property. One of the key challenges is that if you only have one tenant, you’ll be taking on more risk. If the tenant decides to move out unexpectedly, you won’t be making any money until you get another tenant to move in. this will mean that if you took out a mortgage to buy the property, you’ll have to get money off your pockets to pay the loan back until another tenant moves in.
It’s also generally harder for residential real estate to provide the returns that commercial properties would. In case property taxes suddenly hike or the house requires constant maintenance, it can quickly whittle the profits you’re earning away.
Residential property gives you the option of living in your investment. The value of your property will continue to grow with time, even without you realizing. Commercial real estate typically provides the same level of capital appreciation as residential properties but can potentially offer additional cash flow with rental income. Plus, you can opt to rent out the full single-family home, a portion of your own house, and even generate cash flow on a more limited basis compared to a commercial, multi-unit building.
Both residential and commercial real estate have access to owner financing. Since commercial loans come with higher down payment requirements, a buyer can turn to seller assisted financing to offset some of these requirements, or even to completely eliminate the down payment requirement. With residential properties, seller assisted financing is generally more common especially with distressed properties to offer an extra incentive for buyers.
Residential property financing also offers the ability to obtain mortgage insurance for the home, allowing you to finance a bigger part of the purchase price that the bank would be willing to finance without the added protection mortgage insurance offers. This way, you can make a smaller down payment. With commercial properties, mortgage insurance is generally unavailable. Aside from the underwriting requirements for larger loans and the lack of insurance, a commercial loan would require a larger down payment.
Commercial vs. Residential Real Estate: Which is Best?
The right answer will ultimately depend on what you intend to achieve by investing in real estate, and your current financial situation. To earn the most returns, a commercial building for sale in Philadelphia is the right way to go. Residential properties will generally be more appealing to those who are comfortable working on a small scale and generating moderate returns. If you’re still having trouble deciding where to invest your money, consider the amount of time you will be willing to devote on the project and your risk tolerance.