Pros & Cons: Single family vs commercial investing

Summary

It’s very common (but by no means mandatory) that investors have a few single family home investments before they start looking into commercial real estate investments. 

I’m often asked if one is better than the other. Unfortunately, I can’t answer that for each investor’s specific situation, but there are massive differences between the two strategies that all investors should consider as they pursue their individual goals.

In both spaces you have short term strategies which will have higher risks for higher payout potential, and long term strategies which will have lower risk and lower reward profiles. 

In this post I’ll talk through the pros and cons of each strategy. And assume that taking on the single family route will be done either on your own or with a partner, and commercial investing will be done passively through a group investing structure.

Single Family Home Investing

This comes in many forms, but typically will be either long term rentals or home flipping. 

Flipping will bring you much higher returns when done correctly, but will also bring on more risk. The short timing of the business plan along with no cash flow during the flipping period make this plan more exposed to market timing. 

For longer term holds, cash flow is generally very low with more considerable returns at sale or refinance years in the future. For those curious about the cash flow amounts, I have a friend who is big in the single family long term rental mentoring space, and he tells his students to expect ~$200 per month per rental net from all expenses including mortgage. 

Pros of SFH investing: 

1 - Can get started quicker than commercial investing

2 - More loan options for retail investors compared to commercial real estate

3 - Control over the business plan and execution

4 - Can bring higher payoffs with no or limited partners involved

Cons of SFH investing: 

1 - Requires your time as an active partner. Lots of time is going to be spent looking for great deals. 

2 - Property managers don’t take all the work off your plate, meaning they will still require mental commitment to manage managers and do bookkeeping and other tasks a property manager will require help with. 

3 - More risk to diversify outside your neighborhood. It is harder to get diversification without intimate market knowledge or time commitment to build a team.

4 - Limited access to top tier managers and contractors until you hit larger scale of properties in an area.

5 - Lack of income diversity with just 1 tenant.

Overall SFH investing can be lucrative if you’re willing to put in the time and effort to find great deals, execute on a business plan, and actively manage the project. 

The drawbacks are the pulls on your time and effort which will be required to see those results through. There is also additional risk with a lack of income diversity with one tenant being responsible for paying all the bills. If that tenant skips or stops paying, all income in the property stops but the expenses will keep compiling. 

Commercial Investing

Commercial investing has similar strategies, you can flip properties (think of flipping 40% - 60% of units in an apartment complex) or keep them for long term holds. Both have the same risk/return profiles as their respective strategies in SFH investing. 

In my experience cash flows have been greater with both strategies in commercial investing, and one huge benefit is the diversity of income. While you flip units in an apartment building, you generally have lots of tenants continuing to pay their rent and cover your expenses which gives you cash flow even during renovations. 

Commercial investing also has more options for partnerships, with large institutional investors having strategies to accept retail investors into their deals. You can benefit from decades of experience from large teams and companies to execute on the business plan and mitigate risk through their connections, scale, and experience. 

Pros of Commercial Investing

1 - 100% passive as a limited partner. Fund your investment, and get paid distributions of cash flow and sale/refinance. 

2 - Access to institutional sized teams to find the deals, qualify for financing, execute on the business plan, and handle bookkeeping and tax paperwork along with other admin work needed. These teams also sign on the loans and take on any additional financing or due diligence risks.

3 - Diversification of income. Income can come from rents, late payments, charging for premium parking spots or garages, leasing to billboards or renting out common areas, charging back for utilities, and other tactics to boost income. 

4 - More control over expenses. With larger buildings there are more options for vendors and you can leverage more negotiating power by having more work available to contractors, lawn care vendors, and other service providers

5 - Access to diversification. Because you’re a limited partner, you don’t need to be in the area to execute on the business plan. The operator handling the investment will be local and you won’t be limited by your geography. 

Cons of Commercial Investing

1 - Lack of control once the property is purchased. While this is a pro for many people, your position as a limited partner means you won’t be making decisions on the property level. You’ll have to invest in a group you trust to execute on the business plan. 

2 - Shorter term loans. For investors looking for long term strategies, most commercial properties don’t have 30 year mortgages like single family lenders have. Loan terms are generally between 3 - 10 years with a few exceptions that some properties can qualify for 30 year loans.

3 - Potential restrictions in who can invest. While these investments have become much more available recently, some investments may require you to be accredited to invest in their offerings ($1M net worth not including your primary residence OR $200k income annually as an individual OR $300k income annually if filing your taxes jointly with a spouse).

Conclusion

Both strategies have pros and cons, the number 1 factor I recommend you use to determine which strategy you focus more on is how much time commitment you’re willing to put in to find great deals and manage their business plans. 

If you’re willing to commit additional time and energy, you can have success in single family investing, if you’d rather be passive, there are tons of benefits to commercial investing that single family can’t offer.

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