If you’re interested in real estate investments, one of the first decisions you have to make is whether to invest in residential or commercial real estate. Any properties that generate income are considered commercial. Residential properties are typically purchased by people who intend to live there.
A lot of people let their instincts direct them toward investing in residential properties, because there’s an inherent familiarity—everyone has lived somewhere before, whereas leasing property for a business is a much less common experience. Rather than letting unfamiliarity direct you away from commercial real estate, take the time to consider what kind of property would genuinely suit your financial goals better.
One of the major differences between the two types of properties is in how their values are assessed. Residential properties are usually assessed based on comparable properties that have sold in the area. Often there are many “comps” to look at for any given residential property, which is why this easy method is used. Many people are already familiar and comfortable with this method of assessment; either they, or friends or relatives, have likely at least considered purchasing a home.
Commercial properties tend to have few, if any, comparable properties to look at. That’s why there’s a completely different method used to assess them. Commercial properties generate income every year, and that income is the basis of the property assessment. It’s a little more complicated than the comparison method but not hard to understand. It’s based mostly on the net operating income of a property—the income that it generates after expenses—and the price paid for that property. This gives an idea of the return on investment a piece of commercial real estate can offer. It’s affected by a number of other factors, too: what kind of tenants currently lease there (are they reliable, long-term tenants with good credit?), market conditions, the demand for that kind of property in the area, etc.
One effect of this difference in the way properties are assessed is that it’s easier to increase the value of commercial properties. If the neighbors are selling similar-sized homes for a certain amount, your property’s value may be pegged to theirs whether you’ve made lots of improvements or not. However, any method of increasing the net income generated by a commercial property can increase its value, regardless of what the neighbors are doing.
Unlike stock market investments, real estate has inherent, lasting value; that property still exists when the market crashes and has a better chance to recover value over time. Will you choose to buy residential or commercial real estate?