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When building a real estate investment portfolio, there are two fundamental property types that investors can choose from – commercial real estate and residential real estate. Understanding the key differences between commercial and residential real estate is crucial for investors to select the right asset types to match their investment goals and capabilities.

In this blog post, we will thoroughly compare the differences between commercial and residential property. You will learn more about and explore differences in typical property types, lease terms, tenant base, management needs, zoning and regulations, taxes, financing issues, risks, and more.

Whether you are just starting out in real estate investing or looking to expand your portfolio, grasping the unique advantages and challenges inherent to commercial and residential assets is essential to making informed investment decisions. Carefully weighing the differences between these two divergent real estate categories will enable investors to zero in on the market segment that best aligns with their skills, interests, and financial objectives.

WHAT IS COMMERCIAL REAL ESTATE AND IT’S TYPES?

Commercial real estate (CRE) refers to any non-residential property that is used for business purposes rather than as a primary residence. There are several major types of commercial real estate properties.
Office buildings are one very common type of commercial real estate. This category includes both large high-rise office towers in urban downtowns as well as smaller professional office spaces in suburban areas. Office buildings generate income for owners through payments of rent by tenants.

Retail properties make up another major CRE category. This includes shopping centers, strip malls, standalone restaurants, car dealerships, retail stores, and other similar properties focused on retail and hospitality businesses. Income is generated through tenant rent payments as well as percentages of sales revenue in certain retail establishments.
Industrial properties are an additional CRE type. This includes warehouses, distribution centers, manufacturing facilities, production plants, and flex spaces suited for light industrial use. Tenants in industrial properties are usually manufacturing, logistics, warehousing, or similar companies.

Special-purpose properties make up a final category of commercial real estate. These are unique buildings tailored to specific business uses outside of traditional office, retail, or industrial needs. Examples include hotels, hospitals, data centers, funeral homes, gas stations, car washes, and more.

What is Residential Real Estate and its Types?

Residential real estate refers to properties where people live and dwell as their primary residence. There are a few main types of residential real estate properties.

Single-family homes are stand-alone, detached houses occupied by a single household or family. They may be owner-occupied or rented out by an investor to tenants. Single-family homes offer privacy and personal outdoor space that is not found in denser housing options. They are most commonly found in suburban neighborhoods.

Multi-family homes are residential buildings with multiple separate housing units for rent or sale. Apartments are rented units within a larger complex that has shared amenities like a pool. Condos are owned units within a larger complex where there is joint ownership of public spaces. Other examples are duplexes with two units, townhomes that are attached to row houses, etc. Multi-family homes are found in both urban and suburban areas.

Manufactured homes, also known as mobile or modular homes, are factory-built homes assembled offsite and then transported to the site. They offer an affordable homeownership option for many buyers. Manufactured homes can be placed permanently on owned land or moved between rented lots as needed. This category includes mobile homes and prefabricated modular homes.
Benefits of Investing In Commercial Real Estate

Higher rental income:
Commercial leases are longer (typically 3-5 years or more) compared to 1 year for residential. This provides a more stable long-term income.
Base rents for commercial space are higher per square foot than residential units.
Commercial leases often have built-in annual rent increases of 2-3% to keep pace with inflation.

Lower vacancy rates:
Commercial real estate in strong business markets sees lower vacancy rates than residential properties.
There is a higher demand for office, retail, or industrial space from business tenants.
Careful tenant evaluation helps ensure reliable tenants that fulfill lease obligations.

Larger investments:
Class A office buildings and shopping centers have very high valuations, often in the tens or hundreds of millions.
Commercial real estate allows larger capital investments than feasible with even large residential apartment complexes.

Limited upkeep:
Maintenance costs are lower for commercial buildings compared to residential properties on a per-square-foot basis.
Tenants want move-in ready space but handle their own interior improvements and maintenance needs.
Common area maintenance is mostly limited to lobbies, elevators, parking lots, and sometimes janitorial.

MAJOR DIFFERENCE BETWEEN COMMERCIAL AND RESIDENTIAL PROPERTY

While both commercial and residential real estate offer investment opportunities, there are some major differences between the two:

Management:

Residential properties can often be self-managed by the owner, especially smaller single-family rentals. Hiring a property manager is common but more cost-effective than commercial.
Commercial properties require professional property management to handle the specialized needs of business tenants. This includes services like maintenance, security, landscaping, trash, etc.

Lease Terms:

Residential leases are typically 1 year or month-to-month. This offers flexibility for tenants.
Commercial leases tend to be 3-5 years or longer initially, with options to renew. This provides stability for business operations.

Tenants:

Residential tenants are everyday people and families looking for a place to live. They present higher risk than businesses.
Commercial tenants are companies with business needs for the space. They tend to have better credit and financials.

Zoning:

Residential zoning restricts properties to living uses like houses, apartments, etc.
Commercial zoning allows for business uses including office, retail, industrial, etc. Zoning depends on location.

Taxes:

Residential landlords pay ordinary income tax rates on rental revenue.
Commercial landlords can take advantage of more generous depreciation deductions to shelter income. Capital gains taxes are also lower on commercial property sales.

Financing:

Residential real estate can be financed with lower down payments, better terms, and lower costs.
Commercial loans require a 20-25% down payment and higher interest rates/fees. Lenders also scrutinize business financials.

Utility Rates:

Residential tenants pay standard residential electricity, water, and garbage rates. Usually landlord covers.
Commercial tenants pay higher commercial utility rates and are often responsible for payment directly.

Conclusion

The major Difference between Commercial and Residential Property properties revolve around lease terms, tenants, regulations, management, taxes, and financing. Commercial real estate offers higher income potential and lower volatility but requires more due diligence and capital. Depending on your investment goals, both commercial and residential real estate can be sound additions to an investment portfolio when chosen carefully. The key is understanding the differences between commercial vs. residential property before investing.

FAQs

What defines commercial or residential property?

Commercial properties generate income through business activities, while residential properties are used for dwelling purposes. Zoning laws have specific definitions for commercial versus residential based on property use.

What is residential versus commercial location?

Commercial properties are located in commercially zoned areas designated for business activity. Residential properties are located in residentially zoned neighborhoods catering to dwellings.

Are apartment’s commercial or residential property?

Apartments are considered residential real estate even though they generate rental income because they serve as dwelling units. The income comes from housing tenants rather than commercial business activities.