Investing in real estate is a great way to diversify your investment portfolio. It is also considered to serve as a hedge as your other investments in equity markets. But let's get into real estate as a general form of investment before we dive deeper into the types and their differences.
Real estate investments essentially involve the purchase, ownership. management, sale/rental of property. This can further include real estate development, which is the up-scaling and creation of old/new properties from their existing form or from scratch.
The main difference between the types of real estate comes in relation to the use case they offer to the people using it. This creates two sets of broad divisions - namely residential real estate and commercial real estate.
Residential real estate is primarily used for housing and living purposes. This can be in the form of single-family houses, townhouses, studios, etc. most people who opt to invest in residential real estate don't usually use it themselves, but rent it out to earn a steady monthly/ income.
Commercial real estate on the other hand is a property that is used exclusively for business-related purposes or to provide a workspace rather than as a living space, which would instead constitute the residential real estate. Often to leverage this, commercial real estate property is usually leased out to earn income from this.
Despite their intended purpose of use, there are several other factors one must consider before getting into the world of real estate investing. Discussing the main differences between the two options, here are a few factors one must consider before they make their decision.
ENTRY BARRIER
It is harder for commercial real estate investors to access debt. Traditionally banks lend at a lower LTV (Loan to value) ratio for commercial ventures when compared to residential ventures. Commercial LTV ranges between 40-60% while residential borrowers can even get an LTV ratio of 90%.
Typically, CRE loans comes at a higher interest cost and greater risk ratio.
RISK RATIO
In the long scheme of things, commercial real estate has a better return due to their long-term contracts/lease agreements. Commercial properties are leased for 10 years + guaranteeing a steady monthly payment with a gradual increment over time.
Residential agreements are usually of a time frame spanning between 6 months to a year. So the chance of a steady long-term return from the tenant primarily depends on one’s ability to continuously find tenants!
PROPERTY MANAGEMENT
Property management is one of the biggest deciding factors when it comes to real estate. Commercial real estate requires a lot more manpower and management process to keep things in order. A CRE property usually tends to have multiple tenants which further increases the land lord’s management strain.
Residential properties on the other hand tend to have fewer management hassles and also the number of tenants isn’t very high. One house is usually occupied by one tenant and this reduces the workload of the landlord.
ROI
Though commercial properties come with their fair share of additional requirements and also require a larger capital investment, the ROI is one of the biggest attractive features of the investment opportunity.
Having longer contractual agreements when compared to residential tenants, the rental income on top of the capital appreciation is what drives flocks of investors towards commercial properties!
Therefore, it’s a great idea to invest in a commercial property that already has existing tenants, compared to a vacant commercial property.
To conclude, both Residential and Commercial Real Estate come with their own set of advantages and disadvantages, hence the investor should choose one depending on their investment capacity, risk appetite and usage requirements.
Keep up with "The BHIVE Alternative Investment Series" for more detailed blogs about the opportunities and investment avenues available in the market.