The world is changing rapidly and radically these days for several reasons, and these changes are affecting every single human being on the planet in one way or another. In addition to forcing everyone to live differently, the current COVID-19 pandemic is also forcing investors to reassess their short-term and long-term strategies given all of the fluctuations and tumult in so many different markets. What was taken for granted as normal one year ago no longer is, and that may not be changing anytime soon. If you’re an investor in real estate, you may be wondering what your next steps should be, especially when it comes to commercial vs. residential real estate.
Commercial vs. Residential Real Estate – The Definitional Differences
The first point to make with regards to commercial vs. residential real estate relates to how they are different. Some people will think of residential real estate as family homes, single-family dwellings and the like, and to some extent that’s correct. Many people will also think of commercial real estate as office buildings, retail centers and such, and once again, that’s partially correct. However, the differences are more detailed than that.
Specifically, residential properties are defined as those that exist as single-family dwellings, but this category also includes all residential properties of up to four separate units. Therefore, condos with up to four units, duplexes and quadruplexes are all seen as residential in nature. In addition, residential properties are leased to individuals and families.
Commercial properties do include the types of developments listed above, but they also include any property that contains five or more units. Therefore, an apartment building with as few as five separate units would be seen as commercial in nature. Following the type of tenant idea from above, commercial properties are also rented to business entities.
Commercial vs. Residential Real Estate – Differences in Norms
Another important difference regarding the commercial vs. residential real estate question involves the norms that exist. For instance, when it comes to commercial real estate, the cost of entry is typically higher than it would be for the residential market, as commercial properties are usually of higher value than homes or small apartment complexes. That also creates a situation of potentially higher risk.
The customary lease terms are also different when analyzing commercial vs. residential real estate. It’s not uncommon for residential leases to run for 12 months or less, and it’s not all that unusual for these residential leases to be offered on a month-month basis. Obviously, that creates a higher risk for the residential investor, as turning over tenants creates costs and the potential for having to pay the mortgage without rent payments for a period of time. Commercial leases tend to run much longer, with many ranging between five and ten years.
Commercial vs. Residential Real Estate – Differences in Valuation
Perhaps the biggest difference regarding the commercial vs. residential real estate question centers on the valuation of these properties. Anyone who has ever bought or sold any home has an understanding of how residential valuation tends to work. A home’s value is determined by several factors, including:
- Neighborhood comps – The sale prices of similar homes nearby
- Age and overall condition of the home
- History of upgrades and remodels/additions
- Size of and space inside the home
- Lot size
There are other factors, but basically a residential property is valued based on the local market and some individual factors. All of this determines the overall market and what you can expect, at least in general, to obtain in terms of offers if you sell a residential property.
This mode of valuation is vastly different from how it’s done with commercial properties. Yes, certain aspects are somewhat similar in that the commercial property’s overall location and condition will be considered at least somewhat, but for the most part that value is determined almost completely by the amount of revenue that property generates. As such, if you have a beautiful, enormous and new commercial property but it’s only at half capacity, it’s not going to command nearly as much in a sale price as an older building that’s been full for years and that’s always generating an appreciable amount of revenue.
Why This Last Difference Matters So Much In the Current Market
Ultimately, real estate investing is all about understanding current market conditions and being able to see where things are headed. In that regard, this is where the entire question of commercial vs. residential real estate turns towards the residential side of things when it comes to wise investing. There is no other way to put it: 2020 was a brutal year for commercial real estate. Consider the following statistics just for starters:
- The Retail Industry: According to an article recently published in Yahoo! Finance, experts believe that at least 25,000 retail stores are going to ultimately close their doors in 2020. This comes on the heels of 2019, when nearly 10,000 stores closed. This is partially due to the continued growth of the Internet as a marketplace, but it’s also closely tied to COVID-19.
- The Restaurant Industry: Given all of the restrictions on dining out because of the pandemic, the restaurant industry has suffered immensely in 2020. According to statistics published by Bloomberg, more than 110,000 restaurants have closed across the United States in 2020, and the final figures are not even in yet. Not to mention, more than one-third of restaurant operators predict that they will be out of business within six months.
- The Office Space Industry: As most of us already know, the concept of “going to the office” changed dramatically in 2020 due to COVID-19. What many may not realize is just how widespread this phenomenon was during the year. According to FlexJobs.com, more than 40 percent of the current American workforce is working from home, and the number of people expected to continue to work from home by 2025 is 36.2 million people. That represents an increase of 87 percent when compared to the year prior to the pandemic.
As you can see, things are changing quickly on the overall landscape of the United States with regards to how people shop, how they eat and enjoy leisure time and how they work. Those are just three examples of different aspects in life, but consuming goods, eating and working represent a large percentage of all the activities that people engage in on a daily or weekly basis.
As we mentioned above, the biggest factor in valuing a commercial real estate property is the amount of revenue it generates. With tens of thousands of retail outlets and over 100,000 restaurants closing along with tens of millions of people now working from home, that means that countless commercial properties are finding themselves struggling to attract and keep tenants. Fewer tenants leads to lower revenue, and lower revenue leads to lower values for many of these commercial developments.
This reality also leads to the obvious answers to the obvious questions that arise from this ongoing situation:
- Where are people shopping these days? They are shopping from home.
- Where are people eating these days? They are eating at home.
- Where are people working these days? They are working from home.
Residential properties have not been this lived-in since before the Industrial Revolution, and that’s a new norm that could be in place for the foreseeable future. It also means that overall, the question of commercial vs. residential real estate when it comes to investing leads to a pretty clear answer.
The Gatsby Investment Difference
Gatsby Investment is a real estate investment firm that has produced enormously positive results for several years running. We do so because of our keen awareness of the market and our extreme diligence. We target investment types that are high in demand. When we analyze our next investment steps, we don’t just look at what historically had potential to make money, we look at what is a good investment RIGHT NOW. For instance, there is a big shortage of homes in Los Angeles. We focus on the smaller residential multifamily homes because they are quicker to build and easier to sell. That’s how our approach continues to do well despite the current pandemic.
Finally, when you talk with us, you’ll immediately understand that we are utterly transparent in what we do, how we do it and what you can expect. Contact us today to find out how you can get started!