Commercial versus Residential for Investments

Real Estate

Commercial Vs. Residential: Which Investment Makes You More Money?

 

Property buyers new to real estate investing may wonder: should I buy commercial or residential property? Which one is more lucrative?

Let’s take a look at the differences between the two so you know which one is right for you. The top real estate agents Bellevue, WA investors rely on lend their experience so you can avoid costly mistakes and turn a profit faster.

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Residential Properties Offer Lower Barrier to Entry

 

For most people just starting out in the real estate investment business, funds are limited. Depending on the size of the residential property you want to buy, the barrier to entry can be much lower than that of commercial property.

For example, purchasing a home or duplex to rent out is going to cost less that buying an office building in most communities. You have to be able to afford the same down payment and monthly mortgage as if you were buying your own home. This is much more feasible for new investors.

 

Residential Investments Perform More Consistently

 

Historically, residential properties have performed better as investments than commercial properties. Why? For one thing, even during economic downturns, people need to have a roof over their heads.

Also, when the economy dips, residences may lose their value, but they nearly always recover eventually. Over the long term, houses tend to increase in value to the point where the older the home is, the more coveted it becomes, as long as it's well-maintained.

Take a look at homes for sale in Bellevue, WA. You’ll notice many historic homes have above-average prices for the area. But residential properties don’t have to be antique to command a lot of money. Even mid-century modern homes have held their worth well and fetch a nice asking price for owners.

Many business properties, on the other hand, don’t weather economic troubles as well as residential ones. When the economy tumbles, companies lay off staff and go out of business. Over time, what initially looked like a modern commercial space becomes dated and worn looking, particularly if these buildings have stood vacant during times of recession.

 

Residential Properties Are Simpler to Analyze

 

Most first-time real estate investors know what to look for in a home. You check out the condition of the property, evaluate the aesthetics and amenities, and get an inspection. If you’re purchasing an apartment building, you do that for each unit.

Would you know what to look for in a commercial property? How would you know if the features of the property would meet potential renters’ needs? Commercial properties can involve tricky components, such as:

• Complicated plumbing and electrical systems
• Multi-zone HVAC systems
• Internet and technology connections
• Commercial-level security systems
• Refrigeration and retail storage
• Restaurant-scale kitchens
• Shelving and display cases
• Large-scale signage
• Major parking lots
• Elevators and escalators
• Automatic doors
• Commercial fire alarm and suppression systems
• Assembly and other factory equipment

Are you ready to analyze all of those elements if there is a problem with the inspection or if renovations are needed?

 

Residential Properties Are Easier to Finance

 

Because of the issues listed above, residential properties are much easier to finance for new real estate investors. Lenders don’t want to give sizable loans to the inexperienced for commercial properties. If they do, the loan could be considered higher risk, which means it will carry a greater interest rate and require a larger down payment. Lenders don’t usually offer loans for commercial properties if there is a high loan-to-value ratio, hence the large down payment to compensate.

The amortization of commercial property loans is different than that of residential loans. Usually commercial property mortgages come with a large balloon payment at the end of a relatively short term, like seven years. With residential mortgages, however, the borrower pays the same amount each month until the loan is paid off. Extending the repayment schedule on a commercial loan brings a much higher interest rate--which is not good for profits.

Other points to consider for commercial property loans:

• Most lenders won’t loan to individuals, only corporations.
• All the extra fees associated with a commercial loan (closing costs, loan origination fees, survey fees, appraisal fees, etc.) are higher than with residential loans and not as easy to roll into the loan itself.
• Commercial property loans have more restrictions on prepayment.
• Lenders want to know your DSCR (debt-service coverage ratio), meaning how you intend to use the property to pay off the loan. If you’re investing and hoping to lease the property out, your DSCR would be too uncertain for most lenders.

 

Residential Investments Have a Larger Buyer Pool

 

One of the few things residential investment properties have going against them is the size of the buyer pool. You’ll find more competition from fellow investors when you’re first looking at properties. However, there is a silver lining to this cloud. If you buy homes to flip, you’ll know there’s always a large group of buyers looking for residences. This guarantees demand and may let you drive up your asking price when you’re ready to sell.

So, what conclusion can we draw from the information above? Commercial property loans are probably best left to experienced real estate investors. Residential properties, when all is said and done, are simple, practical, and stable, thereby offering a better return on investment (ROI) for buyers, especially those new to the property investing.