Which is more attractive: Rental income from residential or commercial property?

Which is more attractive: Rental income from residential or commercial property?

If you are planning to invest in property to earn returns, which type of property should you choose – residential or commercial? We analyse the benefits and drawbacks of each

Rental income is an important consideration, for people who want to invest in the real estate sector. Property buyers are often confused over which would provide better income option – an investment in a residential property or a commercial one. Arvind Nandan, senior real estate professional, points out that the broad principles of asset-selection, such as the location of the property, quality of construction, age of the property and usage, remain similar between residential and commercial properties. “While most residential properties need to be leased on an annual basis, commercial properties are leased for longer tenures. The vacancy risks in residential properties are higher, given the frequent turnovers of tenants. Hence, property buyers need to pay attention to the qualitative aspects of these two segments,” he explains.

How to calculate rent on commercial property in India?

Experts advise that any investment in commercial property (other than for self-use), like office, retail, warehouse, etc., require the potential purchaser to consider aspects like the current leasing environment, the existing ecosystem in the region, distance from complementary and auxiliary industries, legal due diligence, clearances that are specific to the property’s usage, etc. On the other hand, a residential property must be analysed for liveability with respect to social infrastructure, the neighbourhood and profile of other residents.

How to calculate rent on residential property in India?

“In residential realty, the gross rental yields are usually in the range of three to five per cent, per annum, on the fair market value of the property. Net of insurance, property tax and maintenance, the net yields tend to be in the range of two to three per cent per annum. Escalations in home rentals are between five and seven per cent, per annum. On the other hand, in commercial realty, the gross yields are usually in the range of six to 10 per cent, per annum. Net of insurance, property tax and maintenance, the net yields tend to be in the range of five to eight per cent, per annum. Escalations in rentals here, are between three and five per cent, per annum. The overall returns estimate over 10 years, are now around eight to nine per cent per annum in the residential realty sector, in comparison to 13-15 per cent per annum in the commercial realty sector,” explains Amit Goenka, MD and CEO at Nisus Finance.

Risk versus rewards between commercial and residential properties

  • Tax benefits: Commercial and residential properties that are let out, attract tax on income from house property. However, a house property that is taken on a home loan, qualifies for tax breaks under Section 24 and Section 80C of Income-Tax Act.
  • Risk and volatility: This is perceived to be higher in a residential property, due to frequent change in tenants, higher maintenance and upkeep costs and lower returns. Commercial properties offer stable, long-term rentals, with predictable income streams.
  • Entering and exiting an investment: Both are illiquid assets. However, with Real Estate Investment Trust (REIT) regulations, it would be easier to create a portfolio of commercial properties than residential properties. Also, since the supply of Grade A pre-leased assets is low, the demand is much higher, making it more liquid than residential properties.
Above all these considerations, it is also important to examine the location, investment size and tenure, before making the final decision to invest in a residential or commercial property.

Benefits and drawbacks of investing in residential property

Benefits Drawbacks
Lower entry ticket Low rental yields / rental incomes
No minimum / lowest size applicable Investment in interiors, etc., to make it rent-friendly
Loan facilities easily available Rental agreement usually cannot exceed 36 months
Leasing process is usually easier
Comparatively lower holding period for returns, as against commercial property

Benefits and drawbacks of investing in commercial property

Benefits Drawbacks
Higher rental yield and returns The capital values of commercial properties tend to remain stable for longer periods of time
Longer term lease possible, i.e., up to nine years The property may need to be of a specific minimum size, to be commercially viable
Leasing can be in bare shell or warm shell Difficult to offload, as there are fewer buyers in the market
Commercial values are not very volatile

Beware of this if you are investing in commercial property

In order to make profits out of a sale, developers may lure prospective investors by showing them a higher rental. This is misleading at times. Understand that they may be including a fitout rent and these are not permanent and so, not bankable. They are paid for a limited period of time which can be say, five years.

So, how does that work? Suppose, the base rent is Rs 60 per sq ft and the fitout rent is Rs 40 per sq ft. The tenant will pay Rs 100 per sq ft, which is Rs 1,200 per sq ft per year. Now, if the actual selling price is Rs 6,000 per sq ft where a tenant does his own fitout, a developer may charge higher, say, Rs 9,000 per sq ft, promising a higher return. This may look attractive but once the stipulated time period is over, the returns will drop.

Source: housing.com

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