Commercial vs. Residential Property: Which is the best investment?

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Commercial vs. Residential Property: Which is the best investment?

Posted by: Thomas Anderson in Useful News May 31, 2019

Most personal finance experts agree that investment in property is a wise move. However, many also warn that there are many points to consider and choices to be made, and these decisions should not be taken lightly.

One such decision is the question of whether to invest in residential and commercial property. This is a choice that should be made carefully and involve the careful consideration of your overall investment strategy. Both types have their advantages and disadvantages, and to a large extent the right one for you will depend on your own preference and individual situation.

Investment is good

In an article published on Smart Asset, personal finance writer Rebecca Lake writes that first-off any investment in property is a good one as it diversifies your portfolio and spreads risk. She adds that real estate is also traditionally a more stable investment and less prone to market-related wings.

The question she says to ask yourself is what you wish to accomplish with your real estate investment. Residential real estate might be better for a starter or a small-time investor while commercial properties would be more suitable to those who want a higher return on investment but are also willing to take the risk.

Author of the Complete Idiot’s Guide to Investing, Joshua Kennon, writes in an article for The Balance that real estate is a much more complex investment than most people think. “When you invest in real estate,” he adds, “your goal is to put money to work today and make it grow so you have more money in the future.” He suggests using a financial tool called the capitalization rate to determine which type of investment will be right for you.

Investopedia writes that any real estate investment can enhance an investor’s portfolio and remains a good source of income compared to other classes of investments. “Real estate has a low and in some cases, negative, correlation with other major asset classes meaning when stocks are down real estate is often up,” they added. The authors add that the main negative about real estate investment is that a building may be difficult to convert to cash when you need it and even if you have a buyer it can take months to close.

Commercial Real Estate: Pros and Cons

Commercial real estate would include office buildings, shops, warehouses and land. They are used to produce an income. Lake writes that these properties have significant income potential and a good return on investment given that operating costs can be kept low. She adds however that these types of properties can probably not be managed by an individual and would need a property manager and that you would likely need a large upfront payment and there are likely to be ongoing maintenance expenses.

In an article published on Investor Junkie, Ruth Lyons writes that commercial real estate is the better investment. She argues that the market value of commercial real estate is determined with a more precise approach by using the revenue generated by the property. She adds that commercial properties generally have longer leases than those for residential real estate providing a “more reliable cash flow”, lower vacancy rate and lower turnover costs.

Investopedia adds that between 2000 and 2010 commercial real estate showed returns of 8.4% over the decade based on data from the National Council of Real Estate Investment Fiduciaries. She does add though that residential property have proven itself to weather economic downturns better as people always need a place to stay.

Residential Real Estate: Pros and Cons

These would include places where people live like houses, condos and apartments. Lyons explains that an investor makes money from residential real estate in three ways: cash flow generated by rent, appreciation of the building and equity building by paying off a loan.

Kennon however warns that investors should not assume that property values would always increase as the real estate collapse of 2007 to 2009 proved. He said in order to make money on residential real estate it is important to learn when to buy.

Lake writes that an investor can make a decent return on investment with a single property they can manage themselves and lower ongoing maintenance costs. She adds that it is also easier to get finance for residential real estate. Lake warns that residential real estate does have its risks as tenants can leave unexpectedly leaving the investor without a rent payment. The profit margin is also lower, she adds.

Writing about property trends for 2019 Ingo Winzer, the president of Local Market Monitor Inc stressed that the demand for single-family rentals and apartments are likely to remain high this year but not at the high-end of rents.

He writes that he believed that even with interest rates going up rentals will remain a solid investment for long-term stability. Lyons adds that for the first-time investor it is easier to get into residential real estate and also lower-risk. She adds that there are also a considerably larger number of properties (see for instance those on offer at Bayut) to pick from and a steady demand from rentals.

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