23 NOVEMBER, 2022

Over the years, investing in properties has been a standard method of diversification. Enjoying significant returns due to a secondary income is one of the key benefits of real estate investment.

Real estate investing has many key advantages, such as tax savings, property ownership, rental income, etc. Additionally, it is not as erratic as the equities markets. These have increased interest in real estate investments. Which property investment is more advantageous if earning a side income from rents is an investor's primary goal? Commercial property investment or residential?

While both of these types of real estate investments offer significant advantages, there are a few things to remember when investing in real estate, such as the availability of tenants.

Despite various variables, the real estate industry, particularly the residential sector, has withstood the test of time and emerged as the perfect investment for those with a medium to low-risk tolerance. Most investors favor the residential segment due to the larger initial investment required for commercial real estate.

However, each category has its pros and cons. Most people are unaware of these distinctions and concentrate more on one kind of real estate investing. Let's clarify the situation.

Different Characteristics of Commercial and Residential Properties

  • The primary distinction between commercial and residential property is that investors in the former choose to focus on homes, flats, and villas that they may live in or lease to tenants. Investors in the latter group concentrate on real estate, including stores, offices, hotels, warehouses, restaurants, etc.
  • Since individuals reside there, the relationship between a tenant and a landlord in a residential space is more personal & private than it is in the case of commercial real estate.
  • A renter in a residential rental property only requires limited infrastructure and utilities, which is why a residential property's operating costs are lower than those of a commercial property. Renting estate as a concept emerged as a result of the need for inexpensive housing.
  • Although commercial real estate costs more, the return is higher because the rents are more expensive and the lease term is longer. In the case of commercial real estate, the risk is more significant, but the profit is also bigger. Unlike residential property, commercial property's rental value can drop significantly when the market slows.
  • Even though commercial properties have greater rent, space and location can significantly impact the property's rental value.
  • Additionally, because the rent is lower, it is simpler to locate tenants for residential real estate than a commercial one. Also, residential real estate can be resold with less effort than commercial real estate.
  • Additionally, the owner of a residential property is accountable for maintaining it. In contrast, the tenant is in charge of a commercial property.
  • But regarding legal issues, registration, etc., buying commercial real estate is trickier than buying a residential one. In the event of a residential property, delayed possession might also be a significant drawback.

Rent in the Commercial and Residential Real Estate

Gross rental yield in India for residential real estate typically varies from 3%-5% of the property's market value annually, while they rise to 6%-10% for commercial properties.

According to the real estate website Housing.com, the overall returns predicted over ten years are presently about 8%-9% per year in the residential real estate sector, compared to 13%-15% per year in the commercial real estate sector."

Let's use an example to help you understand: If someone spends, say, Rs 2 crore for a three-bedroom home in a posh area of Gurugram, they may expect to receive between Rs 36,000 & Rs 42,000 in rent each month. Thus, the annual rent is almost 4,00,000.

Additionally, the rent is influenced by various criteria, such as the proximity to surrounding amenities, in this case, the metro and significant malls, shopping centres, hospitals, workplaces, etc. The rent typically rises by 8%-10% annually, although it might sometimes stagnate or even fall somewhat if the market weakens.

In the case of commercial real estate, spending Rs 5–6 crore in a desirable area might bring in rent of about Rs15–20 lakh per year. However, unlike residential property, the lease is set for a more extended period; thus, there is no yearly increase. The upside potential is also constrained because the rent is already on the upper end.

The maintenance cost of a commercial investment can be unaffordable despite the increased rent, which lowers the actual return you receive.

Since both have advantages and disadvantages, choosing between them might be challenging. The investor's financial objective will ultimately determine the response.

Commercial real estate is safer and more reliable because of the huge rent. The lease is lengthier, so you won't have to deal with various tenants if your budget is not a concern and you want to generate higher rent over the long run.

However, residential property is the best option if you have a small budget and limited maintenance skills. You may quickly sell it or utilise it to collect rent.

Residential units can be much easier to handle if you operate on a small scale, even though commercial property gives more significant returns.

Before making a decision, the investors must consider all the relevant aspects, including the maintenance, budget, operational costs, connectivity, rent, the availability of tenants, and market conditions.

Summary: Rewards V/s Risks For Commercial Vs Residential Property

While investing in commercial or residential properties, there would be certain risks and rewards; let's sum it up in this last section.

  • Tax advantages: All the rent income, whether commercial or residential, is taxable. However, if you are acquiring a property with a home loan, you are eligible t get a tax advantage under Section 80C and Section 24.
  • Risk: Residential properties experience frequent tenant turnover and higher upkeep and maintenance. It also brings in lower risks, investment volatility, and returns. Whereas commercial properties can provide a decent investment in the long run, the volatility and maintenance costs can go high.
  • Entry And Exit: Investing in and withdrawing from a position involve illiquid assets. However, with REIT restrictions, building a portfolio of commercial buildings would be simpler than one residential one. Additionally, demand is substantially higher because there is a shortage of Grade A pre-leased assets.

Getting a loan against property is also easier if you need instant money for any work plans. Typically commercial businesses often take up loans against property to grow their business.

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Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.