Investors often face the difficult decision of choosing between investing in commercial real estate vs residential real estate. Each of these investments has its own benefits and drawbacks. There are some differences between both of these that investors must understand. Before that, however, investors must understand what constitutes real estate and what it means.
What is Real Estate?
Real estate is a term used to describe property that consists of land, buildings, and other improvements. These improvements may include furniture and fixtures, utility systems, roads, structures, fences, etc. Real estate presents a diversified investment for investors and can be a crucial part of the asset allocation process. There are various types of real estate in which investors can invest, including residential and commercial real estate.
What is Commercial Real Estate?
Commercial real estate is any property used exclusively by businesses, such as companies, organizations, and other similar entities. Usually, these businesses can obtain commercial real estate through leases. The type of commercial real estate that each business uses will depend on its needs. There are several types of these properties, such as restaurants, hotels, stores, office space, malls, etc.
What is Residential Real Estate?
Residential real estate is any property used for residence purposes. These may include family homes, duplexes, mansions, condos, cooperatives, etc. Similarly, residential real estate is not available to businesses but only to individuals. These individuals can get the right to these properties through leases or acquiring them through mortgages.
What are the differences between Commercial Real Estate and Residential Real Estate?
There are many differences between commercial and residential real estate, some of which are as below.
Risks
Investors face risks investing in both types of real estate. However, due to the stable nature of cash flows from commercial real estate, these risks are relatively lower than residential real estate. Residential real estate leases are generally short-term and favour the tenant. For that reason, residential real estate investments are relatively high-risk.
Returns
Both commercial and residential real estate can provide decent returns for investors. However, commercial real estate returns are higher compared to residential real estate. It is mostly because investors can charge more rent per square meter for commercial property than residential real estate. On top of that, investors also have to account for maintenance costs for residential spaces. These are not usually an issue for commercial properties.
Barrier of Entry
Due to the lower prices of residential real estate, the barrier to entry is lower for investors. Usually, residential properties require less capital investment compared to other types of real estate. In contrast, commercial real estate has relatively higher barriers to entry. Besides, investors cannot obtain debt for commercial real estate easily due to the lower loan-to-value ratios for these properties.
Volatility
Both commercial and residential real estate investments provide investors to develop diversified portfolios. However, residential property usually performs better in times of economic downturns compared to commercial real estate. Commercial properties experience higher volatility due to businesses failing in economic crises.
Conclusion
Real estate represents any property that consists of land and improvements, such as buildings, furniture, and fixtures, utility systems, structures, etc. Investors can invest in commercial or residential real estate as a part of developing a diversified portfolio. However, both of these are different from each other. Residential real estate is different from commercial real estate in risks, returns, barriers to entry, and volatility, among other things.
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