6 November 2020/ sale_commercial_property_guide

Commercial vs Residential Real Estate Investments - Pros and Cons

Commercial properties for sale at Realla

Investing in real estate can be a great way to grow your capital, but you’ll need to decide whether to join the commercial or residential sector. These two property categories are very different, and you may be more suited to one than the other.

What is the difference between commercial and residential real estate?

Here’s a general guide to the key differences between commercial and residential real estate:

 

Commercial property

Residential property

Profit potential

Higher

Lower

Lease length

Longer

Shorter

Administration & paperwork

More

Less

Tenants

Checked, likely to treat property well

Not checked as thoroughly, may damage property or be a nuisance

Maintenance

Outsourced, tenant usually pays

Can do it yourself, landlord usually pays

Payment collections

Up to three months in advance

One month in advance

Landlord contacted

During business hours

Any time

 

Commercial real estate investment - pros

  • Higher profit potential – Commercial properties tend to involve larger numbers than residential buildings, so landlords are likely to see a high return on their investment. In fact, properties used for commercial purposes usually generate 6%-12% of their purchase price every year, compared to just 1%-4% for houses and flats.
  • Tenant security – Finding tenants for commercial property generally involves an extensive due diligence process, so landlords can be confident their chosen individuals are reliable and trustworthy. They check candidates’ financial strength, credit worthiness and trading history, and could even take a deposit as security.
  • Advance payment – Commercial landlords sometimes have a cash flow advantage over residential property owners, as they can collect rent up to three months in advance, rather than just a month ahead.
  • Professional relationships – Landlords will be leasing their properties to businesses and other organisations, so they’ll operate in a B2B capacity, with professional, civil communications.
  • Highly responsible tenants – Businesses want to appear professional, so it’s in their interests to make sure their premises are clean, tidy and in good condition. While residential renters may not necessarily put effort into maintaining their property, businesses will take pride in a well-kept building.
  • Triple net leases – This type of lease comes in various forms, but it usually involves the tenant handling all property expenses. Usually, commercial tenants either organise maintenance themselves, or cover the costs as a service charge. And if insurance goes up, the tenant pays the premium. All the landlord has to do is cover the mortgage.
  • Work business hours – Businesses will probably contact the landlord during their opening hours, whereas residential tenants can call up day or night. So, commercial landlords should only lose sleep for emergencies or burglaries. Plus, alarm monitoring services are more common in business properties, and they’ll notify the authorities for you.
  • Longer leases – Commercial leases are often longer than residential ones, and can last 10 years, so landlords don’t often have to sacrifice income while finding new tenants.
  • Easy valuation – You can calculate how much a commercial property is worth by looking at the tenant’s annual revenue. The more money the business is able to generate, the higher the building’s value.

Commercial real estate investment - cons

  • Bigger financial risk – Commercial property usually involves larger investments, so landlords can end up at a significant loss if things don’t go to plan. Also, business premises tend to be used by more people than the average house or flat, so the chance of damage, public injury and safety issues is higher.
  • Susceptible to economic downturns – When recessions hit, commercial real estate landlords are at more risk than investors in the residential sector. Businesses can go bust or become unable to make payment deadlines, leaving landlords with large rental arrears.
  • More research – Completing due diligence on both potential investments and tenants takes time. For real estate alone, you need to analyse surveys, planning restrictions, previous insurance claims and property titles. If tenants are already there, you should look at the existing leases, tenant covenant strength and the property’s rental value.
  • More admin – The complex documentation associated with commercial leases means more time spent going over forms and negotiating with future tenants. Often, landlords hire legal professionals to review the paperwork too.
  • Long wait times – If the future occupants think they’ll be unable to afford rental costs from day one, they can request a rent holiday. This factor, combined with the time needed to check the paperwork, can significantly delay the landlord’s first rental payment.
  • Professional work payments – Most commercial real estate landlords are faced with large maintenance bills from time to time. They must make sure the building is safe, and may need to cover the cost of emergency works or major repairs. Property management companies can take on these tasks, but charge 5%-10% of the rental income.
  • Work-from-home culture – This year, many businesses have operated remotely, with employees and bosses staying home. This move towards remote working could continue indefinitely, reducing demand for commercial real estate.

Offices to rent at Realla

Residential real estate investment - pros

  • High demand – More people are renting homes now than ever before. As house prices continue to rise, demand will only increase.
  • Smaller financial risk – Residential properties are normally less expensive than commercial buildings and one-off maintenance payments are likely to be lower. With reduced outgoings, they’re usually considered a safer investment.
  • Safer in recession – Generally, residential property tenants are less likely to default on payments than businesses. Commercial tenants can go bust, but this isn’t a risk in domestic leases.
  • Less research – Residential real estate landlords scrutinise surveys and tenant references, but their due diligence process is much less intensive than it would be for a commercial property.
  • Less admin – Thanks to lower prices and reduced public health risk, residential buildings don’t incur as much paperwork as commercial real estate. With a shorter research process and fewer administrative tasks, landlords can welcome tenants and start generating an income fairly quickly.
  • DIY opportunities – Maintenance issues in houses and flats are likely to be tasks landlords can do themselves with a bit of practical know-how. Taking matters into your own hands can hugely reduce ongoing costs – as long as you do a good job!
  • No waiting – Thanks to high demand for residential buildings, it’s easy to find tenants. There’s lots of competition among prospective renters, so people are likely to act quickly when they’re interested in a property and don’t keep landlords waiting.

Residential real estate investment - cons

  • Less lucrative – Residential buildings generally earn less than commercial properties, so there’s lower profit potential per lease.
  • Bad tenants – Most renters are responsible and respectful, but a small minority of people cause problems. While businesses usually act professionally and maintain their buildings well, residential tenants may miss payment deadlines, demand rent holidays or new fittings, and leave the property in a poor condition.
  • Repair jobs – It can be time-consuming to do maintenance jobs rather than outsource them. Although landlords can save money, they might lose time that would be better spent maintaining or developing their real estate portfolio.
  • 24/7 calls – Issues can crop up at any moment, day or night. In fact, when tenants are out working during the day, they’re more likely to discover problems and contact their landlord outside of usual business hours. If landlords don’t hire a property maintenance service, they should be prepared to act quickly when tenants need help.
  • Short leases – Most lease contracts last for six or 12 months, and landlords risk losing rental income every time a tenant moves out. Plus, they’ll need to advertise the property again and do a deep clean to prepare it for new occupants.

Is commercial real estate better than residential?

Commercial and residential real estate bring their own benefits and challenges. While investing in property for business use can be incredibly lucrative, it also comes with higher risk, as mortgage payments and one-off maintenance costs are likely to be more expensive.

Although you may not generate as much revenue through residential properties, they can be a financially safer option, and cut out much of the admin associated with commercial real estate. But with a good amount of working capital as security, landlords can grow their income significantly through more risky investments.

See the commercial properties currently available for sale at Realla.