Real estate investments can add diversity to your portfolio and spread out the amount of risk you’re taking on. What’s more, you can benefit from the fact that these financial investments have historically been less susceptible to major market swings. Real estate investments can be grouped into two broad categories – commercial and residential property – and each one has its pros and cons. If you’re dipping your toes into real estate for the first time, a financial advisor could help you figure out which type of investment makes more sense for your portfolio. Let’s break down key differences between commercial and residential investments for investors.
The Pros and Cons of Investing in Commercial Property
A variety of properties fall under the umbrella of commercial real estate, including office buildings, retail space, warehouses and raw land. The one thing they all have in common is that they’re designed to produce income. For example, an office building would generate rental income from its tenants. A piece of land can be bought and sold to a real estate developer for a profit.
In terms of the upsides of commercial real estate investment, one that stands out is the earning potential commercial properties offer. For example, if you’re investing in an office space in a city where square footage comes at a premium, you’re in a position to charge higher rates. As long as demand remains high and your operating expenses aren’t through the roof, you could see a decent return on your investment.
A steady cash flow doesn’t come without a price, however. Managing a commercial property investment typically isn’t a one-person show. You’ll likely need to hire a professional property manager to find and vet tenants, coordinate the signing of lease agreements and oversee matters on a day-to-day basis.
Beyond that, you’ll also need to pay for ongoing upkeep and maintenance. Together, those costs can add up and reduce the revenue the property generates. Unless you’re buying shares in a real estate investment trust or investing through a crowdfunding platform, investing in a commercial property also generally requires a large upfront payment.
How Residential Real Estate Compares to Commercial Property
Compared to investing in commercial real estate, investing in residential properties likely won’t be as stressful. Instead of managing multiple tenants, you could be dealing with just one. The ongoing maintenance costs won’t be as high, particularly if you’re investing in a single family home. If you decide to go the fix-and-flip route, you won’t have to worry about finding tenants at all.
Entering the residential real estate market is also easier since you won’t need as much money to get started. If you’re trying your hand at house-flipping, for instance, it’s possible to secure a short-term hard money loan and pay very little money out of pocket (at least when you first take out the loan). But since these loans often allow you to make interest-only payments, you’ll need to be sure you can sell the home and avoid getting stuck with a big balloon payment.
Residential property investments have their drawbacks, however. For one thing, you’ll be taking on more risk if you only have one tenant. If he or she moves out unexpectedly, you won’t make any money until you can get someone else to move in. If you took out a mortgage to purchase your rental property, you’ll have to use your own money to pay back the loan until you find another tenant.
It’s also harder for residential real estate to offer returns on the same level as commercial properties. If the home requires constant maintenance or your property taxes suddenly take a big hike, that can whittle away any profits you’re earning.
Bottom Line: Which Is Best for You?
The answer to that question ultimately depends on what it is you want to gain by investing in real estate. If you want to earn the most returns, you might want to consider investing in commercial real estate. On the other hand, residential properties may be more appealing if you’re more comfortable working on a small scale. Thinking about how much time you’re willing to devote to your project as well as your risk tolerance can make it easier to decide where to invest your money.
Tips for Investors
- A financial advisor can help you put a financial plan together for you investment goals and needs. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- You will need to figure out how much you owe in taxes when your investments pay off. SmartAsset’s capital gains tax calculator will help you estimate how you will be taxed in your location.
Photo credit: ©iStock.com/Robert Herhold, ©iStock.com/zahar2000, ©iStock.com/Milan_Jovic