Which Is More Attractive: Rental Income From Residential Or Commercial Property?
The lull caused by the pandemic in the real estate sector is now behind us. Owing to lower home interest rates, discounts and attractive deals offered by builders and developers, pent-up demand, the continued relevance of remote work paradigm, subsidies under the PMAY schemes, etc., investment activity in India’s real estate is buoyant.
In tandem with this development, the rental demand in the residential segment is expected to grow. With vaccination drive, the office floor plan absorption is predicted to drive rental demand in the commercial space to pre-pandemic levels during the current fiscal. In light of these developments, the prospects of gleaning short- and long-term benefits from investing in rental real estate are optimistic.
Against this backdrop, here’s looking at the top factors that prospective investors can consider before making the decision of whether they should invest in residential sector or commercial sector for better returns.
Returns
Rental yield from commercial properties is usually about 7-8% whereas rental yield from residential properties is about 2-4%. Further, commercial property can allow investors to boost rental growth by driving efficient asset management to drive the property’s value and, hence, the returns. Unlike residential properties, commercial properties are usually leased out for longer periods of time. Commercial leases also contain clauses for financial compensation in case the property is vacated before the expiration date by the tenant.
Given these facts. It makes more sense to invest in commercial properties for better yield.
While rental income from residential property is also regular, property owners always need to be on their toes to fill the vacancies as soon as they appear.
However, a key differentiating factor is that investment amount. In commercial property, the investment is quite high compared with a residential one. The process of earning from it is not as smooth as one from residential property. The next section explains that in some detail.
Barriers to entry
The risks involved with investing in commercial property are higher with regards to interest, covenants, and market fundamentals. Since these properties are used for purely functional purposes, longevity is a key factor at play. Investors need to keep factors such as seismic strength, potential efficiency of operations, multiple tenants, outstanding warranties, etc., in mind before making the big leap.
Once these barriers are overcome, the practice of ownership may throw up a few issues of its own, the major one being that of dealing with multiple tenants. This may cause many operational bottlenecks and require the help of experienced property managers to collect rents, perform repairs on the property, and keep vacancies to a minimum to maximise the value of the assets.
These challenges are mitigated in the case of residential property as owners usually have to deal with one tenant or one family. The advent of digital real estate platforms has not only simplified the tenant screening and onboarding process but also empowered property owners to seamlessly deliver a hassle-free customer experience.
So, to invest in a commercial property the traditional way, one needs to have a bigger risk appetite. Having said that, with the arrival of REITs, investing in commercial has become much easier. Let’s see how.
Arrival of REITs
REITs or Real Estate Investment Trusts are companies that own, manage, and operate income-producing real estate assets typically leased out to big companies. The income generated is then distributed among shareholders as dividends. Investing in commercial real estate is capital-intensive which limited the number of investors to HNIs and groups. The arrival of REITs in 2017 simplified investing in commercial real estate for Indian investors while expanding the ambit of who could invest in this segment.
REITs allow investors or stockholders generate profit from their real estate investments while eliminating the need for them to go out and buy, manage or finance property themselves. REITs function like mutual funds, i.e., holders of REIT stocks can buy and sell units in public trading sessions to earn dividends.
Commercial investing through REITs has many advantages. Besides streamlining the investment process, REITs offer a steady and substantial dividend income and sustained appreciation over time. Being regulated by SEBI, REITs are subject to regular audits. Consequently, information on elements like tax brackets, ownership, etc. is easily available to the investor.
Post pandemic state of affairs
Post pandemic however, the government and banking institutions gave a huge push to the residential sector and commercial spaces saw vacancy levels on the high. But with more and more Indians being vaccinated, and many offices already being opened with partial or full capacity, it is safe and wise to invest in commercial segment through traditional method should one’s investment buffer allows or via REITs.
Conclusion
In conclusion, rentals from both commercial and residential properties have their own sets of advantages and drawbacks. Whereas commercial property offers more lucrative rental income, longer leases, and stability, residential properties benefit from lower entry barriers, and easier access to loans. Investors can make a decision depending on their risk appetite and expected gains. In the end, it all boils down to the needs, preferences, assets, risk appetite, and financial targets of the investor. Indians have always felt more secure investing in a physical asset and whether it is commercial or residential, investment in ither sector will bear fruit eventually.
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