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The following is a guest post from Financial Wolves, a blog focused on helping you make more money to achieve financial freedom.
Although single-family real estate (SFR) and commercial real estate (CRE) investing appears to be one and the same thing, both these real estate categories are significantly different from each other.
Why Real Estate Investing?
Real estate is one of my favorite forms of building wealth over time. It is one of the few asset classes that possess the ability to earn income and capital appreciation over time. Both of which are completely protected by inflation.
As a bonus, real estate has one of the most favorable lending markets out there, which enables you to borrow at great rates and allows you to achieve scale. There are many variations of what makes up a good real estate investment. There are market by market details to consider but also industry types of real estate.
Two that are the most prominent are investing in single-family homes or commercial real estate. I’ll highlight the various pros and cons of each to help you consider the best approach for you to build wealth through real estate.
The way that I’ve built wealth with real estate is by taking my side hustle income and put it towards real estate. For example, the money I made online from blogging has all gone towards buying my second single-family house. I’m already on my way to buying my third.
To start with, let’s take a look at the pros and cons of investing in single-family residences.
Pros of Residential Real Estate Investing
Residential real estate investing offers a wide range of advantages. Below are some of these benefits, which make SFR as the most feasible investment for seasoned as well as entry-level investors.
- Quite Easy to Diversify – When it comes to diversification, single-family residences turns out to be the best option. It allows you to purchase different properties in various parts of the country, having distinguishable characteristics. For instance, you can prefer some areas for appreciation and some for high cash flow.
- Consistency during Economic Downturns – Normally, residential or single-family properties perform well even in economic downturns. This is so, as people always need a place to reside irrespective of the prevailing economic conditions. Even if the economy slows down, owners of SFRs suffer much lower loss as compared to the CRE owners.
- SFRs are Affordable – Buying a single-family residence requires less capital, which makes it easier to get things started. Apart from this, it’s quite easy to understand the relationship between a tenant and a landlord. On the contrary, commercial deals are excessively complicated and the risks are higher too.
- Residential Properties have a Large Buyer Pool – The demand for SFRs is relatively steady when compared to the commercial properties. Hence, it takes not more than one month to rent a residential property in most of the cases.
Cons of Residential Real Estate Investing
Besides the above-mentioned advantages of SFRs, you should also take into account some of its cons prior to investing in this real estate category. A few of these disadvantages are the following.
- Maintenance – In fact, the cost of maintaining a single-family residence is higher than a commercial building. The lack of cost-sharing feature is the basic reason for the high maintenance cost. The single owner has to bear the cost of plumbing, roof repair, and other maintenance expenses.
- Turns Out to Be Risky at times – Investing in an SFR can be a risky move, as only one tenant is paying you the rent. If the tenant evacuates, you stop getting the return on investment. This suggests that you will have no other choice but to pay the taxes, mortgage, and utilities from your own pocket until a new tenant arrives.
- Financing – Financing the single-family home isn’t that easy, as you might think. Although the return on investment (ROI) is higher, financial institutes are reluctant to provide financial assistance for buying an SFR. Even if a bank promises to lend you a residential loan, it requires a lot of paperwork.
Pros of Commercial Real Estate Investing
Investing in Commercial Real Estate is beneficial in many ways. Given below are some of the pros of CRE investment.
- Lease terms are more Flexible –Unlike a large number of state laws that govern residential real estate, commercial leases involve a few consumer protection laws. This makes the lease terms more flexible and easier to handle.
- Low Maintenance Cost – The tenants of a CRE property keep the rented place in good shape, as it is essential for their business. The interests of the property owner and commercial tenants are identical, which persuade them to share the cost of maintenance and improve the overall condition of the property.
- Earning Potential –Normally, investors find commercial properties more attractive due to their higher earning potential. Generally, the CRE also offers an annual return on the purchase price besides the income in the shape of monthly rent. This means the income potential is much higher when you buy a commercial property.
- Easy to Evaluate –Evaluating the price of a CRE is quite easy. For instance, you can determine the actual price of a commercial property by requesting the income statement of the building’s current owner. The determination of the actual price may also involve the prevailing cap rate of the area.
Cons of Commercial Real Estate Investing
Although there are plenty of reasons to invest in CRE, you must keep in mind a few negative issues associated with this type of investment.
- Requires Significant Upfront Capital –Buying a commercial property is a huge investment, which definitely requires more capital. Getting the ownership of a CRE may turn out to be much harder than most of us think. After acquiring the property, you may need to spend some additional funds for making your property more presentable.
- Requires more Time and Attention –If you are an owner of a commercial building, you have to be more attentive and responsive. You need to manage a lot of things simultaneously. For instance, you have to tackle public safety and maintenance issues without any unexplained delay. Hence, being an owner of a CRE is a time-consuming affair.
- Need to Hire Professionals for Maintenance – Even if you are a DIY person who can fix a number of things at your home, you will not be authorized to deal with the maintenance a commercial property. In order to fix an issue or maintain a CRE, you need to hire a licensed professional.
Conclusion on Single-Family vs Commercial Real Estate Investing
When it comes to single-family vs commercial real estate investing, both these real state categories have their own perks and negative aspects. With SFRs, you can minimize the risk and diversify your investment by purchasing different types of properties at different locations. But when investing in a commercial real estate asset, you are risking everything on one endeavor.
This doesn’t suggest that SFRs are immune from any kind of risk. However, risks involved in this type of investment are of lower degree as compared to those associated with CRE. In fact, investing in residential real estate is a great option for newcomers.
Before making any kind of real estate investment, you must have an idea that how to invest in real estate. For example, if you have the knowledge and experience of buying and managing a commercial property, you can make money while also building your wealth.
[Cody’s note: If you want to start investing in real estate today, I highly suggest checking out Roofstock. They are a new(er) platform that helps to connect investors with single-family rental homes. The properties are pre-screened and the customer service is amazing. I was fortunate enough to meet with one of their reps and was blown away by the quality of their business.]