Is There Any Reason Why Commercial Property is a Better Investment than Residential?
Residential properties mainly include apartments, townhouses, family homes where the owner can reside in the property or put it on rent to enjoy the rental income. Individuals as well as families lease in these properties, which becomes their primary place of living. As a result, there is some kind of emotional element involved in this business as it includes homes of families and individuals.
Commercial properties are way different than residential properties and include places like office space, hotels, retail shops, warehouses, public facilities, and many more. Similar to the residential properties, the owner of the commercial property can also operate their business by putting it on lease to tenants. Many organizations prefer to take a rent rather than creating a new building from scratch. It comes in handy for organizations as they can invest the saved money into their core businesses.
The commercial properties are supported by the tenants who deliver goods and services for creating their income. Therefore, these properties become a huge investment market which is not the same in the case of residential properties. Moreover, residential property is majorly considered as a non-productive asset, whereas commercial property delivers a wider range of potential investments.
Major Differences Between Investing in Commercial and Residential Property
Rental income is an essential factor for people who want investment in the real estate field. However, property buyers or owners often get confused over which option would be better for their growth. The doubt of whether to go for residential property investment or a commercial one remains in the mind of every owner. Both the properties have similar principles of asset selection like the location, quality of construction, property age remain same. The major differences from which you can analyze are mentioned below.
1. Processes of Loans:
Commercial properties have made it difficult for the investors to get debt, and even banks lend less loan to value or LTV ratio compared to residential properties. As for investors, this represents placing higher equity in projects. Banks lend around 40-60 percent LTV ratios to commercial property whereas, it lends up to 90 percent to the residential asset. However, along with greater leverage comes higher risk on the borrower and an increase in interest costs.
2. Operational Challenges:
In residential properties, it is quite common to deal with a lot of tenants as it includes individuals as well as households. However, a multi-let commercial property owner may have to see very few tenants, which makes their work way easier. More number of tenants needs experienced property management as it includes rental collection from each tenant and proper maintenance. Here arise operational challenges. Residential property owners may lead to certain mismanagement that can limit the value extracted from investment.
3. Risk Profile:
The term of commercial properties is way longer than residential properties. Due to the long-term nature, these properties are highly secure and generate a more stable cash flow compared to the residential asset. Tenants in residential properties sign for a short lease period, usually around six months or a year, and have the break clauses where they can leave after a notice period. Therefore, the risk profile is higher for the residential property investors relative to the commercial one.
4. Value Return:
The major driver of capital growth over a long-term period is the rise in rental income. Commercial property tenants have contracts for longer periods, and in most cases, leases exceed more than ten years. Whereas commercial property rent remains usually fixed and for a short-term period which reduces the certainty of income for the investor. On the other hand, the commercial property allows more opportunities for growth of rental income and enhances the return on asset.
Benefits of Investing in Commercial Property over Residential Property
1. Qualified Tenants:
While leasing property to a family or individual on rent, it becomes hard for investors to find qualified tenants who can maintain their property. Whereas commercial tenants mainly have corporations or businesses and abide by maintaining the property rules. A qualified tenant eases the life of every property owner.
2. Increased Returns:
Commercial properties have far more attractive returns and cash flow compared to residential properties. Moreover, the value of the residential properties is largely impacted by the comparable properties and nearby areas, and commercial properties are influenced by the amount of return it generates. Therefore, the growth of investor return is more in commercial properties.
3. Longer Lease period:
Commercial leases are much longer, and sometimes it extends more than a decade. On the other hand, residential properties range from six months to a year. This makes commercial property a better option for investment as it generates more cash flow and reliability.
In the end, both commercials, as well as residential property investment, has their own benefits and drawbacks. However, for investors who want to raise huge income in the long run, commercial property has attractive advantages to deliver.