Why Is Commercial Real Estate A Much Better Investment Than Residential Real Estate?

You could read a newspaper or a magazine and wind up with claims that commercial real estate is a better investment than residential real estate.

This is true in some situations but not for most property owners. In most real estate investing situations, residential real estate is often the better investment vehicle and equity investment when the alternative is to expect a return on investment in the bank. Banks are more conservative in lending on residential real estate and are often conservative in the amount of leverage they will accept; as a result, residential income-producing properties usually will not go as far as they might on a commercial real estate investment.

Sometimes A Residential Real Estate Investment Is Better Than A Commercial Real Estate Investment

Fortunately, since 1980, residential real estate has soared at an amazing rate while commercial real estate has stalled and in some places has actually begun to decline in value because of the poor management of the property. Much of this increase in value can be attributed to people who had the foresight twenty years ago to purchase homes in areas that would become their most desired locations.

Using an example from a small suburban city, I would like to claim that both the better investment in property in the past and the better return on investment in the present makes the purchase of either residential real estate or investment property in either a form of residential real estate a much better long term strategy than the purchase of commercial property or income-producing properties.

While residential housing has appreciated at a rate of 10% to 20% over the past three decades, commercial real estate, on the other hand, has declined and in some locations is completely gone.

The appreciation on the sale of commercial property is commonly much better than residential real estate when you consider the depreciation factor. You will generally break even on the sale of commercial real estate after 10 years on a moderate to strong appreciation.

When you consider the minimal amount of mortgage you will need to buy residential real estate and the long-term liability on a commercial property is virtually always greater, I would hesitate to commit to the purchase of a commercial real estate in most locations.

In the past when you had a sufficient amount of equity in your primary residence, real estate values could rise at a much greater rate than the increase in housing values. I am not referring to an increase in appreciation provided by the fact that some areas of the country continue to experience a stable or even decline in values.

I am referring to a situation in which you had the equity in your home increasing, thereby dividing the cost in housing by the increase in value of your home, without taxation of the increment in value as income in your pocket.

This situation is to be found in many areas where property values have appreciated at a steady 3 to 5% rate per year. At this rate, it is not uncommon to have investment properties have appraised values equal to or greater than the rental income resulting from those properties.

This 10% to 25% increase in value almost always occurs over a number of years and the heavier-handed influences that leading to this increase are mostly outside of your control.

Let’s look at an example. You own a duplex that is worth $200,000. At the time of this writing, you owe about $150,000 against the property. Then the property goes up 10% in value (5% of the original value) on its own within a few years.

At this same meeting, the boards of pages of your local newspaper are running an article about how the local median price for a home has increased by 20%. You, self-employed, make a living, have excellent credit and plenty of equity on your family home, so why isn’t this a good thing?

Let’s take the increase in the value of your home and divide it by the amount of equity you have in your home. You can’t divide the increase in value by 1.5 since that results in a negative number, so instead, leave it off the aforementioned equation altogether.

$150,000/$200,000 = $4,500

Divide by $200,000Key: It’s $4,500, and if you were to sell this piece of property at current market value you would be paying taxes on that $4,500!

That makes a significant difference in what it costs you annually.

There are some situations in which you might want to sell this piece of property if you want to meet certain specific goals, such as:

  • College or higher education. An example would be: A student from your old country would be attending a local university. If you took care in doing your taxes correctly, you should be able to claim a tax deduction for the expense of living and related expenses that are connected with riding the bus to and from the university.
  • Transracially relocated.