One of my favorite things about real estate investing is that there’s no one way to do it; you can build a successful business through several methods. There is one line in the sand you’ll come up against, though and it’s deciding whether to begin with commercial or residential real estate. So which is a better investment, commercial or residential?
There is no “better” investment strategy as both residential and commercial real estate have their own pros and cons. Residential is much easier to get into thanks to wholesaling, fix & flips, and rental properties. Commercial properties have a higher profit but require massive amounts of capital and may take years before a profit is realized.
So let’s dive into this more and talk about the difference between commercial and residential real estate. Plus, I’ll give you a few tips about ways you can break into the residential game and what you should know before dipping your toes into commercial real estate investing. Let’s dive in.
What is Commercial Real Estate?
Commercial real estate is an umbrella term used for a number of different investment properties. Any of these are considered to be commercial:
- Retail Stores
- Mixed-Use (Store on the bottom, apartments above it)
- Industrial Sites (this is sort of a gray area as they’ll usually be zoned as “Industrial” but for the sake of argument we’ll leave it here)
- Office Buildings
- Apartment Complexes
- Storage Units
In addition, any residential building that can house five or more families is considered to be commercial real estate instead of residential.
What is Residential Real Estate?
Residential real estate refers to any building that is:
- Zoned residential by the municipality
- Houses anywhere from 1 – 4 families
This includes duplexes, triplexes, and fourplexes even though they’re being used for commercial reasons. Single-family homes are also always considered residential, even if a corporation rents them out for commercial reasons. The only time this might not be the case is if the building is zoned “mixed-use.” If you’ve seen single-family homes that have salons or small shops on the main floor where a living room used to be, that’s most likely going to be zoned mixed-use (and, therefore, commercial).
Which is Better for New Real Estate Investors, Residential or Commercial?
So which is better for you, the real estate investor? You’re going to hate this answer, but: it depends.
In most cases, residential real estate will be an easier way for you to break into the industry. It requires lower capital investments, and sometimes you might be able to get away without investing anything at all. Let’s break down the different ways you might use residential real estate for your investment portfolio:
- Wholesaling – Wholesaling is the term investors use for the easiest method of real estate investing. Essentially, you, as the investor, will get a home under contract and then sell that contract to another investor for a profit. You won’t need to get a loan most of the time because all you’re doing is being the middleman between the seller and end buyer. This is an excellent method for any investor who has a less-than-stellar credit history or might have trouble getting a traditional loan.
- Fix & Flip – Everyone’s favorite reality tv investment method! Fix & flip properties are bought by you (or your company), improved upon, and sold for a markup.
Once you get the hang of these two methods, you can continue through the “lifecycle” of a real estate investor and expand your portfolio with:
- Rental Properties – Unlike fix & flips, these stay in your portfolio and create a steady income stream for your business.
- Hard Money Lending – Once you establish a solid cash flow, you can start lending money to other investors looking for gap financing for their own properties. The great thing about becoming a hard money lender is that you deal with very different expectations than a traditional lender: the loans have a short time frame and a higher interest rate.
- Moving Into Commercial Real Estate – You’ll most likely start as a limited partner or someone who just connects general partners to great deals (more on that in a sec). Once your resume starts filling up, you may be able to move into becoming a general partner who has more power and receives more profit.
A Few Considerations Before Investing in Commercial Real Estate
I caution new investors about starting with commercial real estate instead of residential because commercial requires much more effort (in my opinion, at least).
For one, investing in commercial properties requires massive loans that can get into the tens of millions of dollars and down payments that will take your breath away. It’s absolutely a “go big or go home” investment strategy.
On top of that, commercial real estate takes much longer to turn a profit. This is due to several reasons, but the main reason is how difficult it can be to find a new buyer. It’s common for commercial properties to sit on the market for years at a time, where residential moves within a matter of weeks or months.
The business structure for commercial real estate investment is also unique. With residential, you can set up an LLC quickly and get to work, even if it’s just you in the business. Since there’s so much money at stake with commercial, you’ll typically see a structured corporation that includes a mix of limited and general partners.
Limited partners are those who put the money up for the down payment. They have little say in how the property is handled. When the property is finally sold, they’ll receive back their down payment plus a small share of the profits.
General partners are the ones who sign on the dotted line for the mortgage. They take on much more risk than limited partners. Consequently, general partners have more say in how the property is managed and will take a higher cut of the profits.
One more thing I want to point out: becoming a general partner is not a quick or easy thing to do. Lenders want someone who has been in the game for a long time, who has a resume to back up their signature. If becoming a general partner is a goal for you, you’ve got to start at the bottom and work your way up so that you can develop some street cred and show a few years of steady, successful real estate investing.
The Reality of Real Estate Investing
No matter the route you take, or even if it’s multiple routes, I want to give you some hard truths about real estate investing. Running a real estate business of any size is a long-term game and not one that delivers instant results. Many investors will run their business as a side gig while keeping a day job. It takes a long time before any investor can generate enough profit to run this as a full-time operation.
Is it possible to get there faster than everyone else? Sure, but it depends on a few factors:
- How much money do you have?
- Are you an active or passive investor?
- What time frame are you looking for?
Whatever route you decide to take for your real estate portfolio, I recommend mulling over a few of these points first. Both commercial and residential real estate have their pros and cons, so you’ll need to look at the big picture and what’s realistic for your business goals. The more you understand what you’re up against, the higher chance you’ll have to be a successful investor.
How would you recommend new investors get started? Leave a comment with your tips and let us know.