Real estate investment is one of the best ways to build wealth over time. Real estate represents tangible assets with a finite supply, and there are limitless options to how you can develop a strategy; for example, you can “flip” properties, hold them as cash-generating rental units, or buy and hold while hoping for sharp property appreciation over time.
But as a newcomer in the field of real estate investment, you’ll have the option of starting with commercial or residential real estate—and both may seem appealing. Obviously, you’ll need to spend some time learning about commercial real estate and investment, as well as residential real estate, before making your decision, but at a high level, which is better for beginners?
Barriers to Entry
First, let’s talk about barriers to entry. For the most part, it’s easier to get started with residential real estate investing than it is with commercial real estate investing. There are fewer variables to keep in mind, and the total cost of a residential property is usually less than the cost of a commercial equivalent. In line with this, it’s much easier to get financing for a residential rental property than it is for a commercial property—especially if this is your first investment. Accordingly, if you’re worried about making your first purchase, residential real estate may be the way to go.
You can look at performance consistency in a few different ways. For example, if you’re hosting tenants in a property, you may consider tenant turnover and vacancies to be your biggest source of volatility; but we’ll talk about this in the next section. You can also think about future fluctuations in the economy, as well as the local real estate market. If you time a transaction poorly, you’re going to feel it—the question is, are residential or commercial properties more susceptible to volatility following high-level economic effects?
Generally speaking, residential properties are able to perform better during recessions and economic downturns more than commercial spaces. Retailers and small businesses are often quick to fail in the face of adverse economic conditions, and people are much more reluctant to start a business, which could render your property much less appealing. By contrast, people will always need a place to live—and will prioritize paying their rent, even during economic hardships.
Lease Lengths and Vacancies
That said, overall, commercial properties tend to be much better at managing tenant vacancies. Tenant turnover can wreck your property’s cash flow, and add hours of work to your management responsibilities. Generally speaking, businesses signing a lease for a commercial property are more stable, and tend to sign leases for much longer terms. They’re also less likely to “flake” or suddenly change direction. Accordingly, you may be able to generate a more consistent stream of revenue from a commercial rental property.
Comparing commercial and residential real estate investments in terms of potential return, overall, is a bit like comparing apples and oranges. However, commercial properties tend to be more expensive for both investors and renters, and have more flexibility with how you can upgrade and market them. You can also use your commercial properties in more diverse ways. As long as you’re strategically minded, commercial properties tend to have a higher potential return.
Of course, because commercial real estate is capable of more functions, it’s also more complicated to analyze. If you’re looking for a deal on a residential rental property, you can use a checklist of common calculations (like cap rate) to determine whether the property is a good value for this price. If you’re trying to analyze the value of a commercial property, you’ll need to consider far more variables and possibilities—which can be overwhelming to a newcomer in the real estate field.
The Bottom Line
Commercial real estate offers several advantages over residential real estate, including a higher potential return and more flexibility in what you can do with the property. However, for most new investors, the complexity of commercial real estate deals and the higher barriers to entry make them unappealing. Most novice investors are better suited to starting with a residential property.
No matter what, it’s going to take years of experience for you to master a real estate strategy. As you manage more transactions, take losses, and benefit from big wins, you’ll gradually get a feel for your own preferences, risk tolerance, and style of investing. Within a few years, you’ll naturally gravitate more toward commercial real estate or residential real estate, and you won’t have to wonder which is strictly “better” or more rewarding. Be patient as you cultivate and hone your real estate investment skills.