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The choice of real estate object to buy poses one of the biggest questions in the investment field. Even though the residential real estate market is almost four times larger in value than the commercial one (US$498.60tn against US$115.00tn), there are things to consider when deciding on the object of investment. These two property types have their own characteristics, pros and cons, and certain conditions that need to be met to make the investment profitable.
Residential properties are made for families and individuals to live in via renting or buying. Their list can include houses, apartments, condos — any building that can be used as a home for living. Commercial real estate is intended strictly for business purposes and serves organizations and businesses to conduct their activities.
Let’s take a closer look at these two real estate types to see how they affect the profitability of the investment.
Location Impact on Value and Profitability
Location plays a pivotal role when it comes to the investment value and profitability of both commercial and residential real estate. For example, buildings in European countries are always in demand due to great location and infrastructure. That’s why property for sale in Austria goes out like hotcakes.
Still, the same location can be both beneficial and disadvantageous for different types of properties. A prime urban location adds great value to commercial properties since there are a lot of people who can be attracted to the business. It can also be a great feature for an apartment. However, a lot of people are looking for residential properties in less crowded areas like suburbs, so a central location may not be as popular with such tenants.
Locations that are accessible by car and public transportation and close to developed infrastructure are always in demand among both residential and commercial investors. These are usually the areas that include schools, hospitals, restaurants, and various entertainment options. Such features make them desirable locations for people looking for a place to live, as well as businesses wanting to attract customers.
Zoning restrictions that regulate how certain property can be used, e.g. rented out or used as a business hub, also make a difference. They can hinder the profitability of commercial projects that can face a lack of clients, unfavorable business conditions, etc. Such restrictions can even have tax implications on the business, depending on the area.
How Size Shapes Your Investment
Another important characteristic of any property is its size. The generally adopted idea is the bigger the better. However, together with the size come other considerations, like property prices, maintenance costs, and property management expenses.
For example, smaller residential properties have lower initial investment costs, and maintenance expenses and are easy to manage. However, they also bring less yield due to lower rental income potential. Larger properties can provide higher levels of rental income, but they also experience higher vacancy rates and may be subject to increased tax rates.
Large commercial properties are more expensive to acquire and maintain. However, this gives room for business scalability and leveraging capital. They can also be used for diversification of assets in order to decrease risks. Smaller properties, although are cheaper to buy and maintain, sometimes can barely break even because there is no room for development and growing of business.
Tenants: The Backbone of Your Investment
Tenants are probably the most important thing you’ll have to deal with after the investment purchase. Their types vary greatly: residential tenants are usually individuals or families that live in the property you own; commercial tenants are businesses and organizations that need to rent the space to conduct their operations.
Residential tenants pay the same amount of money every month under the rent contract, so you can count on a stable income. Commercial tenants highly depend on the success of their business, which means they can have volatile profits, take losses, and even go bankrupt. That’s why tenant turnover is also different — lower for residential properties and higher for commercial.
Moreover, occupancy rates are usually better for residential properties, meaning there is less downtime, as apartments and houses for rent are always in demand. This cannot be applied to business since it highly depends on the season, product/service, and demand, as well as the business activity itself.
Tenants’ responsibilities and negotiation dynamics are also more complex for commercial properties, as the process takes time and the engaging of third parties like lawyers from each side. Residential tenants have quite simple obligations and the whole rent agreement can be achieved with a few steps.
Leases: Terms and Obligations
As was mentioned earlier, the commercial lease is a more complex document than the residential one. The terms, conditions, and obligations for business property vary greatly and have a much bigger impact on both the investor’s and business activity.
Rent amounts and increases can be larger and more frequent for businesses. The residential rent sum is stable and can be changed only once a year following the contract. Commercial rent can include the base payment plus the sales percentage and can be increased much more frequently.
In accordance with the payment terms, residents usually pay rent monthly, and businesses in commercial properties can pay it on a quarterly or even yearly basis.
Adjustments to the residential rental agreements can be made by the simple consent of parties due to inflation or changes in property expenses. Commercial agreements often include the stipulation for adjusting rent over time.
Commercial rents are more flexible and adjustable, they have higher tenants’ liability and associated expenses. Residential leases provide more security and stability in terms of costs and conditions but usually put more upkeep responsibility on the landlord.
In Summary
Residential and commercial real estate are both great investments that serve different business objectives. The first type is more stable and straightforward, however, it usually brings lower rental yields. Commercial property can be a more profitable endeavor, but not without its risks, since it mostly depends on the success of the tenant’s business operations.
To make an informed decision, you have to first assess your business goals, needs, and potential risks, as well as the property’s locations, size, tenants’ and type of lease, as these factors play a crucial role in your future investment success.
