Commercial vs Residential: Which investment is better for rental income?

There are major benefits of investing in real estate like owning a property, tax savings, rental income, etc. It is also not as volatile as the equity markets. These have made real estate investments quite popular.

If obtaining a second income from rents is the main aim of an investor, the question arises – which type of real estate investment is more beneficial? Residential or commercial.

While both these types of realty investment have major benefits, there are certain factors one must consider before making any real estate investments like availability of tenants, location, operational costs, maintainability, lease, etc.

Despite the multitude of factors, the real estate space, especially the residential segment has withstood the pressure of time and proven to be an ideal investment for medium and low-risk appetite investors. However, due to the higher magnitude of the initial investment in commercial real estate most investors prefer the residential segment.

But there are advantages and disadvantages in both segments. Most people do not understand these differences and end up focussing more on one type of realty investment. Let’s get a clear understanding.

READ MORE: REITs vs real estate: What should you choose for investment and why?

Differences between residential and commercial real estate

The basic difference between residential and commercial types of real estate is that in the first, people invest in properties like houses, apartments, villas, focusing on properties where they can live or rent out to tenants. In the latter, the investors focus on properties like shops, office spaces, warehouses, hotels, restaurants, etc.

The relationship between a landlord/owner and a tenant in a residential space is more private and close than in the case of commercial real estate since the people are not actually living in that space.

Since renting property as a concept evolved due to the need for affordable housing, a tenant in residential housing needs only minimal and basic infrastructure and utilities which is why the operating expenses of a residential property are lower than that of a commercial property.

However, the rents are costlier in commercial property and the lease tenure is also longer, so while the investment in a commercial property is higher so is the return. While the return is higher in the case of a commercial property, so is the risk. Unlike residential property, the rental value of commercial properties can drastically decline when the market slows.

And while the rent is higher on commercial properties, factors like space, location can deeply affect its rental value.

Also, it is easier to find tenants for the residential property than a commercial property due to lower rent. The resale of a residential property is also more hassle-free than that of a commercial property.

Further, the onus of maintenance of the residential property falls on the owner while in the case of a commercial property, the tenant is responsible.

But acquiring a commercial property is more complicated than a residential property in terms of legal matters, registration, etc. Also, delayed possession can be a big disadvantage in the case of a residential property.

Now that we know the basic differences between the two types of real estate investment, let’s see how the rent would be.

Rent in a residential and commercial real estate

In residential real estate, the gross rental yields are usually in the range of 3-5 percent per annum of the market value of the property while this figure jumps to around 6-10 percent in the case of a commercial property.

“The overall returns estimated over 10 years, are now around eight to nine percent per annum in the residential realty sector, in comparison to 13-15 percent per annum in the commercial realty sector,” realty website Housing.com informed.

Let’s understand with an example, if a person buys a 3 BHK property in an upscale neighborhood of Gurugram for say around 2 crore, he/she can get a rent of around 35,000- 40,000 per month. So per year, the rent received is around 4,00,000.

In addition to this, the rent is dependent on many factors like nearby amenities, in this particular case proximity to the metro and major malls, shopping areas, hospitals, offices, etc. The rent generally increases by 8-10 percent per annum, but can also stay stagnant or decrease a bit in case the market slows.

READ MORE: Busting 5 common myths around real estate investment

In the case of a commercial property, investing 5-6 crore in a prime location can fetch annual rent of around 15-20 lakhs. However, since the lease is fixed for a longer term, there is no increment every year like in the case of a residential property. Also, the potential of upside in rent is limited since the rent is already in the higher end.

One must also note that, despite the higher rent, the maintenance costs of a commercial property can also be dampening, decreasing the actual return you receive.

Choosing between the two can be a difficult decision since they both have a set of advantages and disadvantages. The answer will ultimately depend on the investor’s financial goal.

If budget is not a constraint and generating higher rent for the long term is the goal, commercial property is a better and more stable investment since the rent is higher, the lease is longer so you will not have to deal with multiple tenants.

However, if your budget and maintenance capabilities are low, residential real estate is the way to go. You can use it to collect rent or easily sell it.

Commercial property offers higher returns but if you are working on a small scale, residential properties can prove to be much easier to manage.

The investors must consider all the factors like budget, connectivity, rent, maintenance, operating costs, availability of tenants, and market conditions before making the decision.

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