Ahh, the age-old question: what’s better – commercial vs residential real estate investing?
From our experience, many investors seem to think that you should start out with residential and move on to commercial once you’ve gained some experience. But...
Is Commercial Real Estate Better Than Residential?
The answer may not be so cut and dry. Let’s dive into these dramatically different investment strategies.
It's Easy to Boost the Value of Commercial Properties
The market value of a residential property is largely determined by the average value of comps in the neighborhood (we talk about this a lot, hence why Reunion Investment does residential investing so differently from other firms). This is based primarily on raw characteristics such as how many bedrooms and bathrooms there are. You can update a house with high-end finishes and appliances, but nothing talks dollars like rooms!
Commercial real estate, however, is valued with a more pinpoint approach. Market value is based almost entirely on the amount of revenue generated. This means if you can find a way to build inexpensive improvements, you can deliver a big impact on a property's value if more revenue is being produced.
Commercial Properties Deliver Longer Leases
While residential leases usually run for 12 months, commercial leases typically run for at least three years and up to five and 10 years. Of course, longer leases deliver more assurance of reliable cash flow, lower vacancy rates, and lower turnover costs.
There is, however, one drawback to having a longer lease. If you’re not happy with your tenant, it’s not easy to break a long term lease. This is a benefit on residential leases since you can simply not renew and send them on their way.
During Economic Downturns, Residential Properties Perform More Consistently
Take Covid-19 for instance. During times like these, residential properties perform much better than commercial retail space. When there's an economic downturn, stores and retailers are the first to suffer and it can be deadly for businesses. That means bye-bye tenant.
It doesn’t matter how the economy is doing – people will always need a place to live. Statistics show that tenants focus on paying the rent over other things to ensure they have a place to lay their heads at night.
Residential Real Estate Investing is Easier to Get Into
Most investors start with residential real estate, simply because it’s just easier to understand. I’ll bet that you have rented a home before, or may even be renting currently. It’s easy to understand the landlord/tenant relationship. It’s familiar. And it doesn’t hurt that residential real estate investing takes a lot less money than the commercial side.
You have to put a lot of time and research into finding and evaluating the right commercial property. Risks are higher and there’s a lot of money on the line.
You’ll Have a Larger Buyer Pool for Residential Properties
Like it or not retail is underperforming because of competition from online retailers and even big box stores. This has led to empty commercial spaces in most parts of the country. There aren’t enough retailers to fill these spots, which has driven prices down. It can take up to 6 months to find a tenant for a commercial space – sometimes longer.
Residential rentals, however, have seen steady demand. As we said, everyone needs a place to live. On average it takes 30-45 days to find a residential tenant. Not too shabby.
Commercial Deals Are More Complicated to Analyze
Cash flow, equity buildup, and appreciation. Those are the three ways you can make money through residential properties. Beyond common ratios like return on investment, cash-on-cash return, and capitalization rate, with commercial properties, you need to understand and evaluate these along with many other metrics.
You could almost look at commercial real estate investing like running a small business. The way to make money is by increasing your operating income. Look at maintenance records, rental history, and expenses. These values usually can’t be found in the listing itself. Also, don’t forget to look at the last 12 months of profit-and-loss statements.
Which Is Easier to Finance?
Well, there are two sides to the coin here. While it may be easier to gather large sums for a big, commercial investment, data shows that banks are reluctant to hand out loans for these spaces due to the increased competition from online retailers.
Location matters too. Is the area booming or is it in a rut? Commercial lenders are rarely interested in writing a loan unless there are tenants with long leases already in place. If an owner already has tenants in place, why would they sell in the first place?
Luckily Reunion Investments does things a bit differently. With our main focus being on tertiary markets, the rules are a bit different. Plus, we work with city officials to ensure they realize the value we and investors bring to these areas. This makes it easier to move forward on projects, as well as ensuring a more secure investment. Plus, we work with both commercial and residential developers.
Which Delivers a Better Return on Investment?
Unfortunately, the answer is not so cut and dry. It varies by location and by strategy. Since Reunion Investments focuses on tertiary markets and a completely different investment strategy than simply buying a house or apartment complex in a city the numbers we produce are usually greater than the expected return rate investors have for traditional residential investments.
Same deal for the commercial side of what we do. Commercial investors should still aim for a cap rate of 8–15% and a cash-on-cash return of 10%, but the Reunion difference is the security of the investment itself. Since we build and grow entire communities, your much more likely to have continued success over long periods of time.
No matter where you invest, the most important thing is to keep your risk to a minimum. Reunion Investments’ innovative and unique strategies offer virtually unmatched security because you, the investor, no longer need to rely on others to ensure high property values. The Reunion Investments difference is we help control the entire community to nurture investments over time.