Article at a glance:
- Commercial and real estate property markets have specific benefits and risk levels.
- Investors can diversify their portfolios and follow market trends closely to minimize the risks associated with commercial vs real estate investments.
‘Which real estate market is better to invest in’ is a common question for many real estate investors in Australia. The real estate market is a big investment opportunity in developed countries like Australia. But those unfamiliar with it can have difficulty understanding the differences between commercial vs residential property investment. Both property markets have their own set of drawbacks and benefits. While making a real estate investment, one commonality between commercial and residential property markets is that investors must make informed decisions to have a resounding asset portfolio.
One way of making an informed decision while investing in commercial or residential is by understanding the comparative risks of both investments. Both markets have different capital requirements, differentiating the risk levels between the markets. If you are an investor looking to invest in the real estate market in big cities like Melbourne, we have compiled a comparative list of commercial vs residential real estate investments for you.
Risks Associated with Commercial Real Estate
Commercial real estate refers to properties intended for business purposes, such as office buildings, industrial facilities etc. One of the major risks associated with commercial real estate is that it’s hard to find new tenants once a property gets vacated. Some businesses may move to a new and better location or close down, increasing the chances of the building staying vacant for long periods of time. When a commercial property remains vacant for an extended period, it results in a loss of rental income for the owner.
Another risky factor for commercial properties is market fluctuations. When a state’s economy is strong, businesses are more likely to invest in commercial property, which intrigues more and more investors to follow. The increased interest in commercial property drives the demand for the valuation of commercial spaces for the owners. This also increases the rental fee. However, in an economic recession, businesses lack the capital to invest, leading to lower price valuation, lower rents, and higher vacancy rates.
Significant upfront costs go into commercial real estate purchases or leases. The higher upfront costs make it difficult for investors with limited resources or connections to enter the market. Thus financial strain is a major commercial real estate investment risk.
Risks Associated with Residential Real Estate
Residential real estate refers to properties intended for personal use, such as apartments, condos, and single-family homes. The main risk associated with residential real estate is the potential for tenant turnover. Commercial tenants sign long-term leases, while residential tenants have shorter ones and may move more frequently than commercial ones. This can result in higher vacancy rates and turnover costs for homeowners.
Another risk with residential properties is property damage and maintenance costs. While most residential contracts cover property damages caused to tenants through security deposits, repairing the damages can still be costly.
Similar to the commercial property market, the residential property market is subject to market fluctuations. However, compared to commercial property, residential properties mostly only react to supply and demand parameters during an economic recession.
Commercial vs Residential Property: Managing the Risks
While commercial vs residential investments have unique capital needs, ROI, and risk levels, one thing is common for both. No investment is entirely risk-free. However, with due diligence, investors investing in commercial real estate in Melbourne or others can systematically manage their assets to minimize the risks.
Diversify Your Portfolio: One key strategy to manage risks associated with real estate investments is diversifying your portfolio. Rather than investing all your resources into a single property market, consider diversifying your investments across multiple properties or types of real estate. This diversification can help you thoroughly mitigate the risks of one property or property sector.
Evaluate potential tenants or leases: Before leasing your property, it is best to run a background check on the potential tenants. This includes conducting a background check on credit history and verifying employment and income sources for residential properties. This means reviewing potential tenants’ financial statements and business plans for commercial properties. This will ensure that your potential tenants have the resources to withstand financial shortcomings during a recession.
Follow Market Trends: It is important to stay up-to-date with market trends and economic indicators of the real estate market, such as market and unemployment rates. Following market trends helps investors decide whether to buy, sell, or lease properties, which can minimize the risks associated with commercial vs real estate property investments.