Any type of investment can seem to be very daunting. For those that are thinking of investing in residential or commercial properties, it is imperative that you truly understand the differences between the two before making an informed decision on your investment.
At first, it may seem that the differences between commercial and residential properties are very obvious. Residential properties are buildings that are used or are suitable to be used as a dwelling while commercial properties are those that are used for businesses. However, these two have many more important differences for anyone that is willing to invest should know:
The main difference between residential and commercial properties are your customers. For residential properties, they’re called tenants and they pay you a fixed monthly amount to live on your property. For commercial properties, on the other hand, the main type of clientele are business-owners and companies.
Commercial properties tend to have more investment opportunities compared to residential properties. For example, there are commercial property funds that you can invest in such as:
These are managed funds and allow you to easily invest in the commercial property market with a small amount of investment capital.
Residential properties are used by your tenants 24/7, and therefore, are more prone to wear and tear. However, the problems are usually simpler and can be solved with a simple call to a plumber, electrician or other local tradesmen.
For commercial properties, property maintenance is more complex because these properties are usually larger and house more facilities for your clients. In some cases, an on-site property manager is even required by law to manage its maintenance.
Leasing contracts are usually more in-depth and complex that renting contracts. Leasing contracts are based on accounting standard 19 (AS-19) and usually signed for long term. Because of this, a leasing contract is usually fixed, contrary to a renting contract, which can be changed by the landlord anytime he/she chooses.
Also, after the term is over, the lessee is asked to purchase the commercial property. Renting contracts, on the other hand doesn’t follow any standard and are usually signed for short or indefinite term.
Furthermore, another main difference is that in leasing, the responsibility and cost of maintaining the property lies on the lessee while in renting, it rests on the tenant.
The location of the property is much more important for commercial properties than residential ones. In fact, the main factor to influence a commercial properties value is its location.
In a prime location such as in at a heart of a city or in a business district commercial property is much more expensive when compared to a similar sized property located within the countryside.
This is not to say that location is not important for residential properties. The proximity of a residential property to important facilities like groceries, shopping malls, etc. is important but it doesn’t affect the value of a residential property as much as commercial property types.
The most important advantage is that commercial properties have more income potential than residential properties. This is because your customers are usually business-owners or companies which have more money than families and individuals for residential properties.
On average, commercial properties have an ROI (return of investment) of 6%-12% depending on its location while single family home properties have an ROI of 1% to 4%.
- For renting agreements, the relationship between the tenant and the landlord is usually informal.
- For leasing agreements, however, the lessor and the lessee have a more professional relationship with each other. In most cases, the relationship is even business-to-business if a company owns the property and is the one offering it to their clients.
The businesses that lease commercial properties usually have limited hours of operation unlike residential properties where your tenants live on your property 24/7. This means that you would never have to worry about solving problems on the property outside of business operating hours.
Lastly, commercial real estate investments provide excellent value appreciation rates. There are many reasons why commercial properties tend to increase in value. The biggest contributor to this are new developments in high volume footfall traffic areas, which allows the commercial property owners to not only earn money from leasing contracts but also from reselling the property in the future.
Investing in commercial properties also comes with its disadvantages. One main disadvantage is the large amount of work and time commitment that you need to put into it.
While having tenants on residential properties can be a passive income, for commercial properties, you will need to be more involved especially with the property’s maintenance.
- You also always have to be more aware of how your client is using your property and should maintain a constant communication with them.
- Acquiring a commercial property also requires more capital than acquiring a residential property which means it is much more difficult to start investing on it.
- Although it can give you a higher ROI than a residential property, for investors that have limited funds, this can be a real deterrent.
Investing in commercial properties also poses more risks. These properties are used by more people and thus, are also more susceptible to damage. These are also usually located in busier places which can also cause more damage from vehicles, vandalism, etc.
Determining the value of a commercial property is very different for residential properties. Residential houses usually only require a comparative market analysis (CMA). This process compares the prices of similar properties with the same features on the same neighborhood.