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Should You Invest in Commercial or Residential Real Estate?

By investing in real estate you 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 real estate 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, it’s important to understand how they differ.

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Commercial Property Pros and Cons

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.

Related Article: What Is Real Estate Crowdfunding?

How Residential Real Estate Compares

Should You Invest in Commercial or Residential Real Estate?

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.

Related Article: 4 Risks of Investing in a Rental Property

So Which Is Best?

Should You Invest in Commercial or Residential Real Estate?

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.

If you’re not sure which to invest in, consider talking to a financial advisor. SmartAsset’s financial advisor matching service can help you find an advisor in your area in just a few minutes. You’ll answer about 20 questions about your financial situation and goals. Then our tool uses your specific information to sift through thousands of advisors to find as many as three who meet your needs in your area. Check out their profiles, interview them on the phone or in person and choose who to work with in the future.

Photo credit: ©iStock.com/Robert Herhold, ©iStock.com/zahar2000, ©iStock.com/Milan_Jovic

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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