Commercial vs Residential: Which Investment is Better for Rental Income?

Most investors need help choosing between commercial real estate and residential real estate. Even though both are popular investments, the rate of return and amount of money needed to start can be very different. They offer investors many different ways to make money.

Despite the pandemic, commercial real estate has shown notable resilience. The future looks promising for the industry with the recovery of the trend for office space and data centers, Real Estate Investment Trust (REIT), and the rise of co-working. After being in a holding pattern for a few years, residential real estate suffered greatly due to the pandemic. However, with numerous buyer incentives, things now appear to be improving. 

According to reports, experts forecast that the sector will generate USD 1 trillion by 2030, representing 13% of India’s GDP by 2025.

Indians have historically made successful real estate investments. Still, the wide variety of options and market niches raises a crucial question: is it wise to invest in commercial property rather than the residential property? Even though the answer to that question is not straightforward, let’s explore some factors that might be useful.

The contrast between Investing in Commercial Real Estate vs Residential Real Estate

You have two options for investing: commercial or residential real estate. Most people will stand firmly behind one cause and fight for it. However, both options may be viable depending on your financial situation and goals. Yes, you can use your money to invest in both. But, if we consider maintenance, time spent interacting with tenants, and other factors, renting a residential property is much more effort than holding a commercial one.

As with any other investment, the pros and cons of investing in commercial real estate vs residential real estate depend on your goals and the risks you’re willing to take. Let’s look at some more details.

In terms of Residential Real Estate 

• Most of the time, an investor must pay for a property and take possession of the physical asset alone. Although they can include family members as co-investors, the partnership ends there. 
• If we look at residential real estate, you might miss out on conversing with experienced investors. People typically construct their own homes and rent them out.
• Subletting a property for a defined lease period is another unusual way to become an investor. In this manner, the investor only gains possession of the property for five years or more. Since no purchase is required, the investor can easily switch to another asset at the end of the lease term if the money invested does not turn out well. 
• In any case, the uncertainty of the tenants and the pretty short lease contracts make investing in residential real estate less profitable. However, starting is easier because less paperwork and investment are required.

In terms of Commercial Real Estate

• Individual investors still need help to enter the CRE market. 
• In most cases, a retail investor’s initial investment is quite large. One must clearly understand the market’s demand and supply to better evaluate this investment’s benefits. 
• On the other hand, a property investment firm can be useful in this situation. They can handle all the legalities, leaving you to decide whether an investment strategy is right for you.
• Real estate investment opportunities now include REITs and fractional ownership, making it simpler for retail investors to enter the CRE market. 
• Both options offer hassle-free investment processes oriented toward long-term investments while reducing the initial investment size.

Average Returns for Commercial versus Residential 

As previously mentioned, the investor’s risk tolerance and goals are the two main factors of investment success. Another risk associated with real estate investing is losing money on an investment. The returns on investment would not be sufficient if a property does not attract enough tenants during the investment period. 

Commercial real estate is typically less risky because tenants’ solid lease terms almost always result in a consistent cash flow. On the other hand, buying a residential property can be quite risky because these properties typically have unstable cash flow and the potential for significant changes in market demand.

According to estimates, commercial properties typically yield 8-11 % returns, significantly higher than current residential rental yields (1.5-3.5 percent). 

According to experts, the difference is in the lease agreements. When property taxes and maintenance costs are deducted from rental yields in the residential market, they are typically 2-3% or even lower, while the net yield for commercial properties is 7-8%. The Indian commercial real estate sector offers a better investment opportunity from a yield perspective.

According to the Indian Brand Equity Foundation, demand for data centers is expected to increase by 2025 (15–18 million sq ft), making the prospect of commercial real estate in India promising (IBEF)

The area of real estate most severely impacted by the pandemic’s onset and spread was residential real estate. Not only that, but any decline in economic activity in any sector will first impact residential tenants, who would always want to minimize their losses without a firm, long-term lease agreement. 

Spending in residential real estate for a shorter period makes sense if you have local contacts and a sufficient understanding of the market. It is beneficial for commercial real estate to have long-term objectives that span at least five years. In this manner, the profits make more sense, and passive income frees up your time to consider additional investment opportunities.

Conclusion

Commercial real estate has the advantage of having steadier rents and more concrete, long-term lease agreements, which means that tenants are always available. Commercial properties typically generate higher gross returns with less effort. In most regions of the nation, residential properties provide better returns. They don’t require a sizable capital investment because tenants have no loan and no interest costs. Therefore, think wisely and make the best decision!