Investment in real estate, whether it be in commercial or residential property, is a great way to build your wealth. Both types of real estate properties can allow you to earn rent, thus diversifying your income streams. As a novice investor, however, it may take you time to learn the pros and cons of investing in both types of properties.
Many prefer commercial over residential real estate, although which one is better relies heavily on the perception and interest of the investor. Though, it is important for investors to understand that both types have their associated risks and returns.
As for an investor looking for large gains and wealth appreciation, commercial property would be the ideal choice. This is because the property itself attracts a different breed of buyers/tenants than its residential counterpart. Whereas residential properties are usually rented by families, commercial properties are rented by businesses. And in the vast majority of cases, it is commercial properties that earn higher returns.
Commercial real estate properties in your neighborhood typically comprise of office buildings, retail and industrial buildings, warehouses, and business complexes. All of these properties are sold, leased, or rented to people who are looking to start or expand their business operations.
If you are currently deciding on what type of real estate property to invest in, here are some factors why commercial real estate can serve as a better investment option over residential property.
Easier to Obtain Capital
For a commercial real estate investor, raising funds for a commercial property is much easier than it is for a home — which only has a limited set of financing options. For residential investors, typical financial sources include personal savings, mortgage brokers, mutual savings banks, and Real Estate Investment Trusts (REITS).
In contrast, commercial investors have a wider variety of financing options available. Besides the feasibility of obtaining traditional financing, they can also take assistance from various other sources, including, but not limited to, equity firms, hedge funds, angel investors, and venture capitalists. Furthermore, it’s important to note that banks are more likely to approve loans for commercial real estate investments due to their higher return on investments compared to their residential counterparts.
Fast and Higher Appreciation
Residential properties do appreciate but not as fast or as much as commercial properties. You need to take several things into consideration when appraising residential property. These include overall neighborhood value, location, ease of access, and the history of the house’s price itself. Additionally, buyers will be looking to pay a rate for your residential property that is comparable to the prices of other similar properties sold recently in its neighborhood.
But when it comes to commercial property, the value largely depends on its cash flow and generated revenue. Moreover, you will likely obtain even higher valuations for your investment if your property is conveniently located in an up and coming neighborhood with plenty of thriving businesses surrounding it.
High Return on Investment (ROI)
The cash flow and returns from commercial real estate are extremely attractive. As per the National Council of Real Estate Investment Fiduciaries (NCREIF), commercial investments have an annual return of 12.7% on average. More space on your commercial property obviously means more tenants and hence more business for you. Therefore, the more you invest, the more you earn. Boasting such a high average annual rate of return, it is difficult to ignore the lucrative business of commercial real estate investment.
Investment in commercial real estate requires a relatively higher risk and an even heavier undertaking. Not all investors are willing to put their money or take loans to bet on future gains with commercial property. This, in turn, detracts many investors from the commercial real estate market.
Thus, with only a handful of investors willing to take the risk, competition in this industry remains moderately low. In addition, there are myriad commercial property types to choose from, largely including retail, factory, and office space. This, in turn, brings tremendous diversification of opportunities for commercial real estate investors to distribute their assumed risks amongst several commercial property types in a given market.
Ultimately, the answer to whether you should invest in commercial or residential property solely depends on your interest as an investor. Both come with their own benefits and drawbacks. Regardless, they will diversify your income portfolio and will help you build a source of passive income.
However, if you are planning to obtain a healthy long term investment with greater returns and appreciation, then commercial real estate investment would be the perfect choice.
Finally, as an investor debating between commercial or residential real estate, one must consider tolerance to risks, long term goals, and the amount of capital available to invest. We also highly recommend that, before you begin to compare both types of investment properties, you must be sure that you are fully qualified and are working with an expert realtor to mitigate the associated risks that come with real estate investment.