Commercial VS Residential Real Estate: What Are Their Similarities And Differences

There are two major types of real estate that investors work with. In this article, we’re considering and comparing commercial vs residential, including their definitions and discrepancies in profitability.

Commercial and residential properties: their similarities and differences

You might have found different definitions of what is commercial property and what is residential. Let’s summarize the existing approaches to defining them.

• The commercial properties for sale are the ones that include offices, retail, industrial, and multi-family objects. Thus, a retail store, a gas station, post office, a dental clinic, or your job office people come to every day Mon-Fri 9 to 5 are commercial.

Speaking of the last definition – multi-family objects – they are not as easy as it might seem at first glance. Typically, you have to consider the laws and historical circumstances of every country you’re investing in, in order to classify those as commercial or residential. For instance, in the UK or US, commercial objects embrace those, which accommodate 5 and more families under one roof. In such growing and attractive markets like Ukraine (and Eastern Europe in general), there are historically no such objects, which would be built solely for renting – there are only separated apartments in regular many-story houses and detached homes for 1 or several families under one roof.

• Another definition of what is commercial real estate might be as such: it is a type of property, which you let to businesses, not natural persons.

Although, again, a major part of countries in the world has no prohibition to work and run a small business from a rented apartment or house by natural persons. In the US, for instance, they often prohibit. However, things are simpler when you own a house or another type of dwelling – there are from no to small constraints about running a business in your house. However, if you’re working alone by the computer all day long, being a freelancer (like YouTuber, programmer, or designer), it is nearly impossible to imagine that any landlord would prevent you from doing that and terminate your lease agreement.

The difference might also be based on who is paying for rent: a natural person or a legal entity. This becomes clear by the nature of an account since individuals and companies have different accounts in most countries (according to the banking rules and procedures). Applied taxation might differ because of that as well.

• An additional characteristic of business property for sale or lease might be the complete absence of accommodations for people and natural or artificial obstacles, preventing them from living in a place. Like, imagine you’d try to live in an airport or in an opera house (unless you’re the Phantom of the Opera).

Peculiarities of renting commercial vs residential real estate

Pondering about commercial vs residential, the first thing that comes to mind is that you don’t get the same in the income and stability of rent. The inherent peculiarities of commercial real estate compared to the residential one are:

1. Higher returns. Offices, in general, have large footage, which usually embraces anything – from a few thousand feet to several million feet. A typical office would be anything in between ten thousand and several hundred thousand square feet. Well-equipped offices located in ascending markets have a larger cost of 1 sq. f. And retail stores, including ones leased by luxury brands, are the most expensive market offers. Thus, speaking about both ends of the range, the cost of 1 foot might be from a fraction of a dollar to thousands of dollars. A foot of residential area is 10-100-…-n times less expensive.
2. Qualified tenants. Companies, even startups, are always more qualified tenants than natural persons are. While you often don’t have 100% of information about an individual’s trustworthiness, you have way more publically accessible information about companies. Also, the size of a safe deposit you could take from a company might be dramatically higher than the one you could ask and receive from a person.
3. A possibility to rent out your entire premises by small shares. Imagining a typical office, for a start, we’d have working areas like rooms with tables for a bunch of people. There would also be some cafeteria or other small businesses like a newspaper booth or fresh bakery/doughnut seller. Besides, office rooms might fit huge or humble renters – depending on the size of their businesses. Thus, fraction by fraction, you could safely let up to 100% of every corner and room. That is never possible with a residential area – it’s simply indivisible.
4. A possibility to sub-rent. A company renting too large space might be eligible to sub-rent its part to some other company to gain some cash. Surely, that must be clearly specified in a contract and a company should have some free space to do that. But that could be profitable for you as a primary landlord – the cost of the contract with sublease allowance could be higher.
5. You can easily reshape a modern open space in a case when it suits your current business vision or the needs of a new tenant. In a residential place, that’s humbly possible or would even require a complete redesign of the premises from scratch, which wouldn’t be expedient.
6. Longer lease terms. You could be more assured in your cash inflow when letting for lease for 3, 5, or 10 years in bulk. While tenants might get a discount from you when paying upfront to make it more interesting for them (for instance, for a year or two), you also win by securing yourself in the midterm.
7. Easier to increase value. To make the cost of your entire object higher (as well as to increase the monthly cost of rent for business tenants), in some cases, it is enough to change the furniture to a new one or add an extra diesel generator to keep the equipment for N minutes (to add side surplus to the business continuity of your tenants). While trying to increase the cost of residential real estate, by repainting walls or changing furniture, you might eventually land on only an evanescent fraction of an extra cost.
8. You could tune your place to specialize it. For instance, make a fully equipped dental or beauty clinic so it would only require tenants to get there to start running their business. In return, you could receive a higher rental income per foot than from a free-purpose space. And, when and if a previous tenant leaves, another one will quickly be found for a ready-made business.

But, along with the advantages of commercial real estate, there are minuses:

1. It costs significantly higher to purchase one initially. The difference in the cost from a residential property could reach tens of times (if not hundreds, in top places)
2. Owning it might require bigger tax and special allowances if the country’s/state’s legislation persists.
3. It is hard to find really good commercial places since there is always a deficit of them. Many of them might require renovation, which, considering huge footage, might cost millions.

Conclusion on the matter

Picking between the two opportunities – commercial and residential – one should consider available pros and cons, as well as the budget limitations. Usually, owning commercial estate is only suitable for institutional investors-legal entities or very wealthy individuals since the price tag for becoming their landlord jumps to millions (even tens and hundreds of millions).