jyotikrag

Hi

Wanted to discuss the relative merits of investing in commercial vis-a-vis residential property around the below lines

- Rental yields and capital appreciation
- Ease of entry/exit (ability to source/ticket size/turnaround time)
- Ease and cost of financing
- Vacancy risks/maintenance issues
- any other items

Would appreciate if someone can enlighten on the same.

Thanks

ajaysanghani

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Alees

Here are some merits and demerits of both , you could decide or choose between the two after reading this



Like any of your investment choices, each type of property has its pros and cons. For example:
Residential Pros:
1. Residential units are generally easy to rent. Turnover in housing is high, so your pool of potential tenants tends to be large.
2. Leases are generally short, especially for apartments, so you can keep pace with the rental market. This means cash flow tends to be fairly strong with a multi-unit residential property.
3. Financing residential property is usually fairly straightforward. For smaller properties, the process is similar to financing a home.
4. The cost per unit tends to be lower for residential than commercial. The more units you have, the less likely it is that a vacancy will severely impact your cash flow.


Residential Cons:
1. Residential properties usually require a lot of hands-on management.
2. Residential properties usually require a lot of hands-on management. (That’s not a typo. I said it twice.)
3. With a single-family home, one lost tenant equals 100% lost rent.
4. Multi-family houses tend to be older and therefore may require more repairs and maintenance.


Commercial Pros:
1. Typically leases are longer, with built-in rent escalations. Five years, with options to renew is not universal but certainly quite common. Except perhaps for small offices, few businesses would be willing to go to the expense of becoming established in a particular location without a guarantee of more than just one year.
2. Many commercial leases pass through to the tenant a pro-rata share of certain expenses (or a pro-rata share of the increase in certain expenses, over a base). For example, the tenant may be obligated to pay a pro-rata share of property taxes and common-area maintenance. This helps stabilize the cash flow for the landlord and makes that cash flow more predictable.




Commercial Cons:
1. Trying to purchase a commercial property on a tring may not be a realistic plan. Lenders are generally tougher underwriting commercial loans, especially if you have no experience operating commercial property. Down-payment requirements tend to be higher, as do interest rates. Loans are for shorter terms and often have a “balloon” requirement (i.e., must be refinanced before the nominal end of the term). The property will have to pass muster in terms of its projected cash flows and debt coverage ratio.
2. Leasing a commercial space can take much longer than leasing a residential unit. After a tenant is identified and basic terms agreed upon, it is usually necessary for attorneys for both sides to negotiate the language of the lease. The complexity and cost of this process can vary greatly, depending on whether you are dealing with a local or a national tenant.

jyotikrag

thanks anees. very useful. some additional comments to take the discussion further.

- while its more difficult/time-consuming to get commercial property into lease, the churn is however much lesser. so guess the higher vacancy period risk whenever it happens is somewhat compensated by less frequent vacancies in the first place ??
- on the exit front...while the short-term duration of the residential property leases provide for relative ease of selling once the lease period has expired, dont commercial property provide additional ease of exit as they can be sold on a rental yield capitalization model to other investors even when they are still under lease?? or i am theorizing here and practical experience is to the contrary?
- also any idea of comparative rental yields and like capital appreciation between the two type of properties generically speaking under the Indian circumstances

Yoge1979

Hi,

More addition to the above discussion

1. Leases tend to be much longer – anything from three to 20 years - and they are quite often secured by bank guarantees which makes them a secure investment.


2. Rent is reviewed annually and is usually increased either by the CPI or by 4%, whichever is the greater.


3. Commercial tenants will also tend to maintain the property better as the look and condition of the property is important to their business and their staff. But commercial leases also have added protection for the owner in the form of make good clauses, maintenance clauses and management clauses.


4. The return on invested capital on commercial properties ranges between 7% and 10% net after all costs.