Investing In Real Estate: Residential vs. Commercial

Real estate investments are an excellent way to make a profit. However, you must examine and understand various factors to ensure lucrative deals. Perhaps you have made successful investments with residential buildings and would like to start purchasing commercial real estate. Before you buy any commercial properties, there are some things to consider.

Residential Real Estate

Residential properties are for living purposes and include the following:

  • Duplexes
  • Single-family houses
  • Rooming houses
  • Condos
  • Apartments

Residential properties cannot have commercial or industrial uses as defined by the local zoning statutes.

Commercial Properties

Commercial buildings have business-related purposes. They provide workspaces for income-generating tasks. Some examples of commercial structures include:

  • Office buildings
  • Retail stores
  • Medical facilities
  • Warehouses
  • Malls
  • Industrial buildings
  • Multifamily housing properties

Term Sheets

When you secure a residential mortgage, you usually get a pre-approval for the loan amount. However, in commercial property deals, you typically put the real estate under contract before seeking finance options. Loans for commercial properties do not have a pre-approval process. Instead, there is a term sheet, which is an agreement that indicates the lender is willing to provide funds if you commit to the required conditions.

Amortization

With residential purchases, your loan terminates once you pay the entire principal balance. For commercial real estate loans, the loan term is generally shorter than the amortization schedule. You must understand how this schedule impacts your transaction.

An amortization schedule details how much your monthly payment applies to the interest you owe and how much goes toward the principal amount. It is a fixed table that plans for more of your payments to go toward the principal as the loan matures.

Term Leases

The lease terms you can typically offer tenants with commercial properties are much longer than with residential buildings. The average commercial lease is about three to five years. Sometimes, they can even go up to 20 or more years. These longer terms offer both advantages and disadvantages, depending on the reliability of your tenants.

Recourse

If you default on a residential bank mortgage, the lender takes back your house, resulting in the loss of equity. There are more significant consequences if you do not repay a commercial loan. Recourse loans allow the lender to take the property you mortgaged and go after your personal assets to recoup the total costs.

Penalties

Commercial loans usually have prepayment penalties. These typically require you to pay an extra percentage if you pay off the loan early. Be sure to read your prepayment penalties and understand how lenders calculate the fees before closing the deal.

Commercial real estate offers many opportunities for savvy investors. Take some time to understand the differences between residential and commercial purchases to ensure the best return on your investment.

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