The operations of residential and commercial real estate have many similarities, but there are some key differences, as well. Residential real estate deals with structures in which people live (e.g., your house or apartment). Commercial real estate deals with the buildings where people work and transact business (e.g., a coffee shop or office). Often, these buildings are open to the public, such as in the case of a retail store or restaurant.
The business of a real estate professional in buying, selling, and leasing these properties varies. There are some differences in taxation for each type of property, and the tenants—and their needs and priorities—vary significantly.1 Depending on your goals and how much time and money you want to dedicate, each type of endeavor has its own pros and cons.
Read on to explore several variations within the costs, responsibilities and advantages in commercial and residential real estate.
The Pros and Cons of Commercial Real Estate Investing
As the name implies, commercial real estate investors and agents buy and sell properties where commerce occurs. These buildings can be anything from warehouses to malls and office buildings, or any other structure zoned for a business enterprise.
The maintenance requirements of commercial property usually fall more on the tenant, so commercial landlords often have fewer responsibilities in the day-to-day operation of the property than their residential counterparts do. Think of a restaurant owner who wants to change the business’ branding and repaint the exterior to reflect its new brand colors. It would not be fair to expect the landlord to cover these changes to the structure. If commercial tenants need updates for healthy or sanitary reasons, however, then that is something to raise with the owner and ask for funding.
Ultimately, commercial properties can be significantly more expensive to purchase than residential properties but are much easier to manage on a daily basis.3 If you need to, you can apply for commercial loans to help you with the costs or recruit other investors.
Commercial Leases vs. Residential Leases
Commercial properties are often rented with what is called a “net lease.” These leases can be single, double or triple net leases; the terms refer to varying levels of tenant responsibility for the taxes, insurance and maintenance of the building. With a single net lease, the commercial tenant pays a lower base rent and property taxes, while a double net lease includes the base rent, property taxes and insurance premiums. In a triple-net lease, usually abbreviated NNN, the tenant must handle all the expenses associated with the building.
There are some good reasons for structuring a commercial lease this way. For one, the insurance costs can vary wildly depending on the type of tenant. For example, imagine the insurance needs of a yoga studio compared to those of a woodworking shop that houses sharp and possibly dangerous equipment.2
Commercial sites usually have considerably longer-term leases than residential real estate properties do. Five- and ten-year leases are typical in commercial real estate, which significantly decreases turnover. A good commercial property can have the same tenants—who pay the taxes, insurance and maintenance costs—for decades.
The Pros and Cons of Residential Real Estate Investing
Residential real estate professionals work with the properties where individuals and families live, such as single-family homes, duplexes and large apartment complexes. Managing these properties can be a daunting task. Generally, the owner is responsible for all the expenses associated with the property, from taxes and maintenance to utilities, especially in a multifamily unit where each unit may not be metered separately.4
Despite these costs, residential properties are usually much less expensive to purchase than commercial real estate properties are. A modest single-family home around $100,000, for example, might be secured with a $20,000 down-payment and a $700 monthly repayment, making them accessible to those earning an average of $6,000 per month. This enables many people to take up part-time roles in residential real estate investing and as landlords if they wish.5
While the initial costs of commercial real estate can often be a barrier to entry, the properties can be more profitable and easier to manage in the long run. Many people choose to start in real estate investment on the residential side and then move to commercial real estate as their business evolves.
The Tax Differences Between Residential and Commercial Property
It’s not unusual to get into real estate investment for the tax benefits. The United States Internal Revenue Service (IRS) considers real estate property, but not land, as a capital expense. As much as businesses can use depreciation to write off the expense of purchasing a valuable piece of machinery, real estate investors can deduct the cost of their properties from their taxable income. This is an enormous benefit since statistics show the real estate sector historically performs better than other asset classes.6
The IRS has varying rules governing the depreciation of residential and commercial property. Commercial property can be depreciated over 40 years, but residential property can be deducted over just 27.5 years. This means the residential property owner can realize tax savings much sooner, which provides a financial advantage. In addition, the IRS allows residential real estate property owners to submit a cost segregation study. This can speed up the rate at which some or all of their property can be deducted, sometimes allowing all of it to be deducted in the first year. This can allow landlords with many properties to eliminate their tax burdens for years at a time.7
Differences Between Commercial and Residential Tenants
One of the most significant differences between owning commercial real estate and residential real estate is the variation in tenants and their priorities.
The needs of commercial property owners and their tenants are usually closely aligned with each other. The building owner wants the property to be well kept; in a commercial space, the tenant does, as well. For any commercial endeavor, such as a restaurant or company headquarters, for example, physical space in poor condition is bad for business.
Commercial properties, however, can become highly expensive depending on the area in which they're located. If the property taxes increase, then the property owner will need to raise rent. Hopefully, the property taxes will be increasing because foot traffic and popularity are as well, and that means higher revenue for whatever business or company the commercial tenant is running within the property.
Unfortunately, that owner and tenant alignment is not always the case in residential real estate. Most tenants want their homes well kept, of course, but since the landlord handles maintenance costs, many tenants choose not to go the extra mile. Renters don’t stand to gain equity in the property, so they may be hesitant to make any improvements to the structure (e.g., replacing the gutters). This disparity in need and priority can lead to resentment between the two parties. When coupled with short, year long leases, high tenant turnover and excessive upkeep costs between tenants, residential real estate owners are often left with a continuous battle to maintain the property value.8
The Role of the Real Estate Professional
When dealing in the real estate business, you'll encounter and work with a variety of professionals. If you choose to go into commercial real estate investing, for example, you'll work with the real estate agent who sells the property, a broker, the building manager and/or landlord, contractors and the tenants.
If you choose to invest in residential property, you'll also likely work with a real estate agent, broker, contractors, and tenants, but also possibly a banker and insurance agent.
Become an Expert in Property Investment
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- Retrieved on January 9, 2023, from fortunebuilders.com/commercial-vs-residential-real-estate
- Retrieved on January 9, 2023, from investopedia.com/ask/answers/040115/what-are-differences-between-single-double-and-triplenet-leases.asp
- Retrieved on January 9, 2023, from gnprealty.com/news/differences-between-commercial-residential-properties/
- Retrieved on January 9, 2023, from investopedia.com/terms/r/residentialrentalproperty.asp
- Retrieved on January 9, 2023, from voyagerpacific.com/single-family-home-investing-a-way-to-build-wealth-with-real-estate
- Retrieved on January 9, 2023, from investopedia.com/ask/answers/052015/which-has-performed-better-historically-stock-market-or-real-estate.asp
- Retrieved on January 9, 2023, from rocketmortgage.com/learn/tax-benefits-of-real-estate-investing
- Retrieved on January 9, 2023, from innago.com/understanding-residential-commercial-real-estate-investing/