If you’re contemplating investing in real estate, you’ve probably deliberated over what type of real estate investment would be best for you. Whether you’d rather take on the role of a landlord or instead sit back and watch your investment grow, real estate can serve as a relatively stable investment class that offers the potential for sustainable returns.
Potential real estate investors are faced with many different types of properties to invest in, with the two broadest categories being residential and commercial real estate, with the latter making up a $1.2 trillion market in 2022.
So, how do residential and commercial real estate differ, and how can you choose which is best for you as an investor? Here’s a breakdown of commercial real estate vs. residential real estate to help you get started.
What Is Commercial Real Estate?
Commercial real estate (CRE) at its most basic is any multi-unit property developed as a commercial enterprise (rather than for personal use). These properties are leased to tenants to use for income-generating activities. The four core real estate asset classes are office, industrial, multifamily, and retail. However, more niche asset classes — such as assisted living facilities and self-storage — are now considered part of the general CRE asset class and may be available to self-directed, passive investors through platforms like EquityMultiple.
CRE properties can be categorized into three classes, based on their price, amenities and overall quality:
- Class A: These buildings include newer high-end properties that are the best in their area. They’re catered to tenants willing to pay premium rent.
- Class B: These buildings are often older and targeted for restoration purposes. They are not as competitive as class A buildings when it comes to price.
- Class C: These buildings are generally the oldest and are located in less desirable areas. They usually require a high amount of maintenance.
Next, we’ll break down the flip side of a commercial estate investment: residential real estate.
What Is Residential Real Estate?
Residential real estate is any developed property zoned specifically for living purposes. Investors purchase these properties and lease them out to tenants using a lease or other type of rental agreement. Most often “residential real estate” refers to single-family or small multi-unit properties (duplexes or triplexes).
Residential properties encompass everything from a single-family rental to a small apartment building, including:
- Duplexes
- Three- or four-unit buildings
- Vacation homes
- Condos and townhouses
There are also mixed-use properties that combine residential and other commercial real estate property types.
So, how do these two types of real estate differ in terms of investments?
Commercial Real Estate vs. Residential Real Estate: What’s the Difference for Investors?
The main difference between residential and commercial real estate is what the property is used for and the types of tenants it attracts. Residential real estate is leased to families and individuals for housing purposes, whereas commercial real estate is leased to businesses for income-generating purposes.
Because of this, each type of property has different opportunities for investors. Commercial real estate can help provide investors with stable, diversified cash flow due to a multitude of tenants within a single property, and varied lease structures On the other hand, investing in residential real estate may entail a lower barrier to entry.
But these rewards do not come without risks. Like any material asset, residential and commercial properties are subject to real estate risk factors. For example, natural or man-made disasters could destroy the property without any sign of warning. Risk factors are always important to keep in mind when considering both residential and commercial real estate investing.
Whether you’re an accredited investor or are just getting started, you need to first figure out which type of real estate investment will best meet your investment goals.
So, let’s review some pros and cons of investing in commercial real estate vs. residential real estate.
Pros and Cons of Commercial Real Estate Investments
Like any investment, investing in commercial real estate vs. residential doesn’t come without its risks. While investing in commercial real estate can bring high returns, it may also involve higher renovation costs depending on the tenant that inhabits the property, which can cut into your profits. To learn more about commercial real estate, take a look at the pros and cons.
Pros | Cons |
Cash flow stability |
Historically high barriers to entry for individual investors |
Can help hedge inflation |
More complexity |
High returns |
Risks related to specific sectors |
Capital appreciation | |
More diversification potential |
Pros of Commercial Real Estate
Commercial real estate may be enticing to investors for a variety of reasons, including:
- Cash flow stability: Businesses that rent commercial spaces usually move less often, and many have enough cash reserves to cover a down month’s lease payment. Commercial real estate also has longer leases, with many of them being three years or longer.
- Can help hedge inflation: If you’re worried about inflation’s impact on your portfolio, CRE investments can help hedge against the effects of inflation. In fact, in five-year holding periods, CRE performance has an 84% probability to beat out inflation.
- High returns: Investing in a professionally managed CRE asset gives you the potential to tap into a diversified tenant pool; realize returns driven by skilled management and asset selection (“alpha”); and tap into business plans that have definitive time horizons and return objectives.
- Capital appreciation: While residential property value may swing wildly with mortgage rates and other market dynamics, commercial property value is dependent on the net operating income the building generates. Investing alongside the right sponsors in a broad range of CRE properties can potentially enhance the capital appreciation component of your portfolio.
Now, let’s move on to the cons of commercial real estate.
Cons of Commercial Real Estate
Investing in commercial real estate may also have some downsides, including:
- Historically high barriers to entry for individual investors: Unless you’re using a platform-based investing service, directly investing in CRE can be more costly than a direct investment in a residential property, such as a single-family home. This is because many commercial properties cost more than residential properties, and may require a more expensive down payment. While residential properties still largely require less to get started, platform-based investing services can allow accredited investors to invest in CRE at a much lower cost than directly investing on their own.
- More complexity: CRE often comes with complex requirements and zoning ordinances that can differ from tenant to tenant. Not only that, but the county, state, industry, property size and other factors can influence the regulations your commercial property is subject to. The more complex the regulations are, the more difficult it may be to meet them, therefore eating into your time and money. Because of this, most investors will need specialized knowledge or access to those who do. Again, investing through a quality platform alongside a quality real estate developer can remove these headaches for an individual, passive investor.
- High renovation costs: With residential properties, renovations usually match the needs of future tenants (an updated bathroom, kitchen, etc.). Commercial properties, on the other hand, may have different renovation needs depending on the current tenant and their specialized trade. This can lead to higher renovation costs in the event that new tenants are brought in. However, well-capitalized sponsors can realize economies of scale when making value-add renovations to multi-tenant properties, creating the potential for greater overall returns.
- Risks related to specific sectors: Depending on the type of commercial real estate property you’re dealing with, you may be subject to specific risks over time as industries evolve. For example, the demand for office buildings diminished once businesses began working remotely during the COVID-19 pandemic.
Commercial Real Estate Investor Outlook The capital markets environment in 2024 potentially creates “barbell” opportunity for real estate investors. A ‘higher for longer’ interest rate scenario favors real estate private credit. On the other hand, higher rates and ongoing demand dislocations (the lingering effects of the pandemic) may create distressed asset opportunities. As always (but particularly in an uncertain environment) investors are best served by a diversified approach.” — EquityMultiple’s take |
Back to that flip side of commercial real estate properties, let’s take a look at residential real estate and what investors should know.
How to Get Started in Commercial Real Estate
We’ve covered some of the benefits, but how to invest in commercial real estate? On its face, commercial real estate investing is more complex and daunting than residential real estate. However, a platform like EquityMultiple can help you gain exposure to the asset class easily, and with a low barrier to entry.
Pros and Cons of Residential Real Estate Investments
Just like investing in commercial real estate, investing in residential real estate also has its benefits and drawbacks. Since everyone needs somewhere to live, you’ll quickly have access to a large pool of potential tenants. But these tenants can also cause issues, ranging from property damage to missing rent payments. To learn more about residential real estate investments, read through the pros and cons.
Pros | Cons |
Easier to understand for inexperienced investors |
Offers less diversification |
Easier to access if you’re intent on owning the property yourself. |
Costly repairs |
High vacancy risk |
Pros of Residential Real Estate
Residential real estate can be an attractive investment for a few different reasons, including:
- Easy point of entry for average investors: If you want to own property directly, single-family residential offers a lower barrier to entry. However, even a downpayment in a cheap area will exceed investment minimums on a platform like EquityMultiple.
- Large pool of tenants: Residential properties tend to be easy to find tenants for, as everyone needs a place to live. However, because single-family homes are, by definition, the vacancy risk is much higher than for any multi-unit property.
- Low downside risk in times of economic crisis: Because of the need for housing, residential properties may present low downside risk during times of economic crisis. For instance, the COVID-19 pandemic caused many businesses to close, and few businesses were looking to rent stores, offices or restaurants. Everyone still needed a place to live, though, so residential vacancy rates remained comparatively low. Keep in mind, however, that commercial multifamily offers better downside protection than single-family homes, as lean times push more renters into apartment living and deter would-be homebuyers.
Now, let’s check out the cons of residential real estate investing.
Cons of Residential Real Estate
Of course, residential real estate isn’t perfect. Some cons that could impact your investment include:
- High tenant turnover: People regularly move, many renters have somewhat unstable incomes and lots of people are living paycheck to paycheck. These factors increase the turnover, late payment and nonpayment rates of residential rental units. This is somewhat reflected by residential leases, which tend to range between month-to-month and two years (which is considered long).
- Costly repairs: In many cases, investing in residential real estate leaves many investors with a more active role in maintaining the property. Random mishaps, from plumbing issues to bug infestations, can leave you on the hook for costly repairs to your residential property. And if the tenants cause any damage to a property, property managers have to spend time and money fixing it before they can rent it out again, which can eat into an investor’s profits and delay potential income.
- High vacancy risk: If you’re renting out a single-family residence and your tenants decide not to renew your lease, you’ll quit receiving income while your property sits empty. This makes vacancies hit much harder than if you were dealing with CRE, such as a multifamily investment, where losing a single tenant won’t completely halt your income.
Next up, let’s take a look at how you can choose between commercial vs. residential real estate investing to make the investment that’s best for you.
How To Choose Between Commercial Real Estate vs. Residential Real Estate
Every investment has its risks and no two investors are the same. That’s why the decision to invest in either commercial or residential real estate should come down to your own risk tolerance, investment goals and whether you’d like to invest directly in a property or use a passive CRE investing platform. Keep in mind that passive investments in commercial real estate may offer a faster route to diversification and varied return profiles, versus a single downpayment on a single-family home.
The Bottom Line
If CRE investing sounds like an alternative investing strategy you’d like to add to your portfolio, platform-based investing is a great way to generate passive income through diverse offerings designed to suit real estate investors with different goals and styles.
FAQs About Commercial Real Estate vs. Residential Real Estate
Still have questions about commercial real estate vs. residential real estate? We have answers.
Is Commercial Real Estate Better Than Residential?
Generally, investing in commercial real estate is considered better than residential real estate due to its stable cash flow, high returns and ability to quickly increase in value.
Is Commercial Real Estate Riskier Than Residential Real Estate?
Investing in commercial real estate is generally not riskier than investing in residential real estate.
Is Residential Real Estate Easier Than Commercial?
Not necessarily. While residential real estate may seem like an easier investment than investing directly in commercial real estate, online platforms allow investors to easily participate in passive commercial real estate investing.
Are Electrical Costs Cheaper for Commercial Properties?
In many cases, yes. While the quality of energy consumed by commercial and residential real estate properties is the same, commercial property owners often buy electricity in bulk. In addition, electric companies sometimes offer businesses discounts and tariffs, allowing them to purchase electricity at a cheaper rate than a residential property owner.
Is It Cheaper To Build a Residential Property?
In many instances, yes. Commercial real estate buildings are often much larger than residential properties, leading to more materials, labor and higher costs. Also, the materials used for construction may differ between these two types of real estate. For example, many residential homes are built using a timber frame, whereas large commercial properties often require steel frames, which are more expensive.
What Is Passive Commercial Real Estate Investing?
Passive commercial real estate investing is when an individual invests in a property as a limited partner, allowing them to receive cash flow and capitalize on appreciation without managing the property themselves. While it is possible for an investor to become a direct owner of a commercial real estate property, it requires much more time and capital. With passive commercial real estate investing, you can invest in commercial real estate with another investor or company.
By building a portfolio of passive CRE investments, you can invest in real estate with a much more diverse and balanced approach than if you were to invest in a property as a direct owner.
What’s the Difference Between Commercial and Residential Loans?
Traditional residential loans or mortgages are often given out by banks to individual borrowers, whereas commercial loans are distributed to a company. In the eyes of lenders, commercial loans are seen as riskier and generally have higher interest rates and shorter terms than residential loans. Commercial loans also usually involve a secondary market of commercial lenders that is separate from traditional lending institutions like banks.
In addition, applying for a commercial loan is a more strenuous process than applying for a residential loan. To qualify for a commercial loan, investors must provide a business plan and details related to the property’s projected cash flow, whereas residential loans are based on factors like your income, assets, debt and credit score.