If you’re looking to add a new investment to your portfolio, it’s worth considering the pros and cons of investing in commercial property vs residential property.
This is a question many investors ask, and ultimately it will depend on your own personal preference, and the opportunities available to you.
But, whether you’re team commercial or team residential, or perhaps a mixture of the two, there are a number of advantages and disadvantages to both approaches.
In this article we will elaborate on these to see what are the differences between investing in commercial and residential property.
At A Glance: Investing In Commercial Property Vs Residential Property
| Factor | Commercial Property | Residential Property |
|---|---|---|
| Upfront Investment | Higher | Lower |
| Renovation Costs | Lower | Higher |
| Profit | Higher | Lower |
| Tax Burden | Lower | Higher |
| Maintenance | Lower | Higher |
| Demand | Lower | Higher |
| Income Security | Higher | Lower |
| Lease Length | Longer | Shorter |
| Management | Complex | Simple |
| Mortgage Costs | Higher | Lower |
Investing In Commercial Property
Most people do not automatically think of buying commercial property when they first get into property investing.
That’s probably because most people are much more familiar with residential buildings than commercial ones, and so they stick with what they know.
However, that could be a mistake as there are a number of advantages to commercial property that will appeal to first-time investors, as well as a few negatives.
Advantages Of Investing In Commercial Property
Higher More Secure Income
Rental income is often more secure over longer periods of time thanks to lease agreements. There is a big difference between renting commercial space as a company and renting a home as an individual.
A business tends to rent for long periods of time, which means you have a long-term secure income. Lease agreements for commercial properties can be for years, and if it’s a good spot, businesses will want to stay and renew the lease.
Not having to worry about finding a new tenant all the time can take a lot of pressure off a landlord. And knowing you have a reliable income can also help you plan further investments.
Tenants of a commercial building will also pay rent 3 or more months in advance. This will give you better cashflow and add to the income security.
But commercial rents are also higher than residential ones, giving you a higher return of your investment.
Low Renovation Costs
Often, little to no renovation is needed as the tenant will want to fit out the premises to suit their requirements.
Each business will have their unique requirements when it comes to a commercial space. To get what they want, they will be happy to carry out renovation work themselves. This means you don’t have to spend much money once you have bought the building.
And this means that your rental yield will increase, which is always music to a landlord’s ears.
Lower Maintenance Costs
Most commercial properties are rented with a Full Repair and Insurance Lease (FIR Lease). This means tenants usually have the responsibility for repairs and maintenance rather than the owner.
Insurance is also the responsibility of the tenant rather than the owner with this type of lease agreement. Not only does this mean you don’t need to worry about having the money for repairs, it’s also less hassle.
As such, managing a commercial rental building is easier and more hands-off than a residential rental.
Less Taxes To Pay
The tax burden for investing in commercial property vs residential property is quite different. And the commercial side wins here.
Capital Gains Tax (CGT) will be due on any profit you make when selling a building, regardless whether you are selling a commercial or residential property. However, the rates you pay are different.
For a commercial property the basic rate to pay is 10% and the higher rate is 20%. For a residential one, unless you have lived there with your tenant, the base rate is 18% and the higher rate is 28%.
Stamp Duty Land Tax (SDLT) is also lower if you buy a commercial building. Under current regulations, the maximum rate you pay is 5% for properties with a value over £250,000. For a residential one you could pay 10% or even 12% depending on the value.
Business Hours Only
With a commercial property you deal with businesses. This means you only have to be available during business hours. So no midnight calls that the boiler has broken down.
This is great for a good work/life balance because you know you can switch off after a hard day at work and relax.
Disadvantages Of Investing In Commercial Property
Less Flexibility
While it’s great for income security that commercial buildings come with long leases, this can also be a drawback. That’s because long leases can become more restrictive to the owner should they wish to sell.
Unless you can come to an agreement with your tenant, you will have to find a buyer who is willing to honour the lease agreement with your tenant. This narrows the pool of possible buyers, making it more difficult to sell.
Less Demand
The demand for commercial properties is much lower than for residential ones. With online shopping threatening high street shops and working-from-home policies reducing demand for office space, demand for commercial buildings might reduce even further.
This means if you lose a tenant, it will be more difficult to find a new one.
Bigger Price Tag
Investing in commercial property tends to come with a bigger price tag.
Commercial buildings tend to be more expensive to buy, because you can make a bigger profit. So your initial investment will be higher.
When it comes to mortgages, the battle of investing in commercial property vs residential property is won by camp residential.
You need a bigger deposit, due to the higher asking price, and your monthly payments will be higher than for a residential building.
That’s because borrowing costs will be higher. Mortgages for commercial buildings tend to have higher mortgage rates. Coupled with the need for a higher deposit, this pushes up borrowing costs.
If a commercial property is empty, the owner is responsible for paying business rates. This can be quite costly, especially if the space is vacant for some time.
Given the low demand for commercial spaces, the risk of long periods with no tenant is a real one.
More Complex To Manage
Renting out a commercial space is more complex which means more work and paperwork. Depending on how many properties a landlord has, this can take up quite a considerable amount of time.
While you can hire professionals, such as lawyers, to help, this would be an additional cost, and not a small one either.
Commercial properties also have to adhere to more legal regulations, which can be complex and costly.
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Investing In Residential Property
Residential properties are the ‘go-to’ investment for most investors. They are easy to understand and there’s a plentiful supply of them, which gives you lots of choice as to where you will create your portfolio.
With that in mind, let’s take a look at the major advantages and disadvantages of buying residential buildings as an investment.
Residential Property Pros
Lower Costs
Property prices for residential spaces are quite a bit lower than those for commercial ones. This means the initial investment is lower, making it more easily accessible for less affluent landlords.
This also means that mortgage costs will be lower, because a smaller deposit is needed, and monthly payments will be lower too.
In addition to this, mortgage rates for residential properties are cheaper, again pushing down costs for the landlord.
It’s also much easier to get a buy-to-let mortgage for a residential building than a commercial one.
Easier To Manage
While there are legal regulations for residential buildings, they are easier to follow and less expensive. As a result, a landlord can take care of these themselves.
Managing a residential rental isn’t complicated, so even beginners will be able to get into it.
Increase Value
It’s much easier to increase the property’s value for a residential rental than a commercial one. There are many options that a landlord can take.
From a simple refresh of walls, carpets and kitchens to a full-on renovation project including extending and knocking down walls.
Residential properties will gain value if more space is added, which can be done easily, if not necessarily cheaply, by extending out or up.
Additionally, house prices for residential buildings tend to rise automatically anyway with time.
High Demand
Unlike for commercial properties, demand for residential ones is always high. This means even if tenants leave on a more regular basis and won’t stay as long, finding a new tenant won’t take too much time.
This will reduce the amount of a residential property being empty considerably, reducing costs associated with a vacant building or flat.
Residential Property Cons
Less Secure Income
Residential rentals tend to have short leases, with tenants potentially only staying for six months or a year. This can increase tenant ‘churn’ and leave you with more periods where the building is empty.
As a result, income from rental properties is less secure than from commercial ones, which tend to have long leases. And if a residential rental is empty, the landlord is responsible for paying council tax.
Higher Maintenance Costs
With a residential property, the owner is responsible for all repairs and maintenance that’s needed. This increases the ongoing costs for the landlord, which can have a negative impact on the cash flow.
And some repairs can be quite costly, such as installing a new roof or dealing with damp.
But a landlord is legally obliged to make any repairs within a reasonable period of time after being alerted to an issue.
Depending on the seriousness of the problem, this reasonable period is shorter or longer.
Renovation Work
To attract more tenants/buyers, you may need to completely renovate a property before letting or selling it. This can be costly, especially if you want to increase your yield/profit by adding more space.
As a minimum, a refresh is needed in most residential properties you buy. However, often a new kitchen and bathroom might be required, which can add to the costs.
Structural work, such as knocking down walls or building an extension, can be even more costly.
More Competition
There is a high demand for residential properties, which means it can be more difficult to get a suitable dwelling. High demand also pushes up prices, even if they are still cheaper than commercial buildings.
This is especially true in areas where a high rental yield can be made, such as university cities or up-and-coming areas.
Volatile Market
While property prices for residential dwellings tend to rise, they can also fall. And rental income can fall with it should property prices fall in the area.
Because tenants of residential properties tend to lease for shorter periods, any changes in rental prices are more likely to have an impact.
Conclusion – Investing In Commercial Property Vs Residential Property
So, who wins when it comes to investing in commercial vs residential property?
It probably makes sense for most investors to have a good mix of both residential and commercial investments in their portfolio. This will offer some protection from the different factors that can affect both types of properties such as recessions and popularity of areas.
Better yet, look for buildings that attract both types of tenant. A shop with a flat above, for example, can be a great way to spread your risk and enjoy the best of both worlds.
Overall, whatever you choose, make sure you do your homework and understand exactly what you are getting yourself into. Viewing the property beforehand is an absolute ‘must’ no matter which type you are buying.
If you do choose to make a residential investment, be sure to check out our guide on the top 5 ways to add value to an investment property.
