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 stock markets. These have made real estate investments very popular.

If obtaining a second rental income is the main objective of an investor, the question arises: what type of real estate investment is the most advantageous? Residential or commercial.

Although both of these types of real estate investments have major advantages, there are certain factors that should be considered before making real estate investments, such as tenant availability, location, operating costs, maintainability, lease , etc.

Despite the myriad 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 scale of initial investment in commercial real estate, most investors prefer the residential segment.

But there are pros and cons to both segments. Most people don’t understand these differences and end up focusing more on one type of real estate investment. Let’s get it right.

READ MORE: REITs vs real estate: what to choose as an investment and why?

Differences between residential and commercial real estate

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

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

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

However, rents are more expensive in commercial properties and the lease term is also longer, so even though the investment in a commercial property is higher, so is the return. While the return is higher with a commercial property, so is the risk. Unlike residential real estate, the rental value of commercial properties can drop drastically when the market slows.

And while rent is higher on commercial properties, factors such as space, location can profoundly affect its rental value.

Also, it is easier to find tenants for residential property than commercial property due to lower rent. Reselling residential property is also easier than reselling commercial property.

Also, the burden of maintaining residential property is on the landlord whereas in case of commercial property, the tenant is responsible.

But acquiring commercial property is more complicated than residential property in terms of legal issues, registration, etc. Also, late takeover can be a big inconvenience 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 residential and commercial real estate

In residential real estate, gross rental yields are typically in the range of 3-5% per annum of the market value of the property, while this rises to around 6-10% in the case of commercial property .

“Estimated 10-year aggregate returns are now around 8-9% per year in the residential real estate sector, compared to 13-15% per year in the commercial real estate sector,” the real estate site informed.

Let’s understand with an example, if a person buys a property for 3 BHK in a posh area of ​​Gurugram to say around 2 crore, he/she can get rent around 35,000- 40,000 per month. Thus per year, the rent collected is approximately 4,00,000.

In addition to this, the rent depends on many factors like nearby amenities, in this particular case proximity to metro and major shopping malls, commercial areas, hospitals, offices, etc. Rent typically increases 8-10% per year, but can also remain stagnant or decrease a bit if the market slows.

READ MORE: Busting 5 common myths around real estate investing

In the case of a commercial building, invest 5-6 crores in a prime location can fetch an annual rent of around 15-20 lakhs. However, since the lease is fixed for a longer term, there is no increase each year as in the case of a residential property. In addition, the potential for rent increases is limited since the rent is already at the high end.

It should also be noted that despite the higher rent, the maintenance costs of a commercial property can also be mitigating, decreasing the actual return you receive.

Choosing between the two can be a tough decision as they both come with a set of pros and cons. The answer will ultimately depend on the financial objective of the investor.

If the budget is not a constraint and the goal is to generate higher rents in the long term, commercial real estate is a better and more stable investment since the rent is higher, the lease is longer, you so you won’t 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 sell it easily.

Commercial real estate offers higher returns, but if you’re working on a small scale, residential properties can be much easier to manage.

Investors should consider all factors such as budget, connectivity, rent, maintenance, operating costs, tenant availability, and market conditions before making a decision.

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