Real estate investment has consistently been a sought-after method of diversifying assets. One of the key advantages of investing in real estate is the ability to receive a secondary income with high returns. Some advantages of real estate investments include property ownership, tax deductions, rental earnings, and its stability compared to stock markets. These investments have gained a lot of popularity in the real estate sector. If an investor's primary goal is to earn a second income from rents, they may wonder which type of real estate investment is more advantageous. Residential versus commercial.
Although both types of real estate investment offer significant advantages, there are specific considerations to keep in mind before investing, such as tenant availability, location, operational expenses, maintenance, and leasing agreements.
Even with numerous factors at play, the real estate sector, particularly in residential properties, has shown resilience over time and remains a favored choice for investors with medium to low risk tolerance. Yet, because of the larger initial financial commitment required in commercial real estate, most investors opt for the residential sector.
However, there are pros and cons in each category. Many individuals fail to grasp these distinctions and ultimately concentrate on just one aspect of real estate investment. Let's ensure we have a thorough comprehension.
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Differences between residential and commercial real estate
The main distinction between residential and commercial real estate lies in the fact that individuals mainly invest in properties such as houses, apartments, and villas in the former, with a focus on properties for living in or renting out to tenants. Investors in commercial real estate concentrate on properties such as retail stores, office buildings, storage facilities, hotels, and dining establishments. The bond between a landlord/owner and a tenant in a residential setting is more intimate and personal compared to commercial real estate as people do not reside in those spaces.
The concept of renting property originated from the necessity of affordable housing, so residential tenants require less infrastructure and utilities, resulting in lower operating costs compared to commercial properties.
On the other hand, rents in commercial real estate are more expensive and the length of leases is also longer, resulting in higher initial investment but also higher potential returns. Although the risk is greater when investing in a commercial property, the potential return is also higher. In contrast to residential real estate, the rental income of commercial properties can significantly decrease during periods of market slowdown.
Factors such as size and location can greatly impact the rental value of commercial properties, even though the rent may be higher. Finding tenants for residential property is also simpler compared to commercial property because of the lower rental rates. Selling a residential property is also less of a hassle compared to selling a commercial property. Additionally, the responsibility for maintaining residential properties lies with the owner, whereas for commercial properties, it is the tenant who is accountable.
Purchasing a commercial property involves more complexity than buying a residential property, especially in regards to legal procedures, registration, etc. Additionally, delayed occupancy can pose a significant drawback.
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Rent in a residential and commercial real estate
In the realm of real estate, gross rental yields typically range from 3-5 percent annually for residential properties, whereas they can reach 6-10 percent for commercial properties.
According to information from real estate website Housing.com, the overall returns over a 10-year period are currently estimated at approximately eight to nine percent per annum for residential real estate, compared to 13-15 percent per annum for commercial real estate.
To illustrate, let's consider a scenario: if an individual purchases a 3 BHK property in a high-end neighborhood of Gurugram for approximately ₹2 crore, they could potentially earn a monthly rent of around ₹35,000-₹40,000, resulting in an annual rental income of roughly ₹4,00,000.
However, rental income depends on various factors such as nearby amenities, including proximity to transportation hubs, shopping centers, medical facilities, and business districts. Rental rates typically experience an annual increase of 8-10 percent, although they may remain stable or even decline slightly during market slowdowns.
In contrast, investing ₹5-6 crore in a prime commercial location could yield an annual rent of approximately 15-20 lakhs. Yet, commercial leases often have longer terms, meaning rental increments are less frequent. Additionally, the potential for rental appreciation may be limited since commercial rents are already higher.
It's essential to consider maintenance costs, which can diminish the actual return on investment for commercial properties. Choosing between residential and commercial investments can be challenging and depends on individual financial objectives.
For investors seeking long-term, stable returns and have a larger budget, commercial properties offer higher rent and longer leases, minimizing the hassle of dealing with multiple tenants. Conversely, residential properties may be more manageable for those with limited budgets and maintenance capabilities. They provide flexibility in terms of renting or selling.
Ultimately, investors should weigh factors such as budget, location, rental income, maintenance costs, tenant availability, and market conditions before deciding on an investment strategy.
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Ans 1. How is commercial property rental income taxed? In India, rental income is regarded the same as any other kind of income and is included in the taxable income bands. If the amount received as rental income exceeds Rs. 2,50,000 per year, the property owner will be required to pay rental income tax.
Ans 2. High-Tenant Properties – Typically, properties with a high number of tenants will give the best return on investment. These properties include RVs, self-storage, apartment complexes, and office spaces.
Ans 3. Commercial property investment can be a highly lucrative investment strategy. However, it also comes with risks and requires careful consideration before making an investment decision. Investing in commercial property requires knowledge, research, and a sound investment strategy.
Ans 4. Income Tax on Rental Income: Tax Free RentA person will not pay tax on rental income if Gross Annual Value (GAV) of a property is below Rs 2.5 lakh.