Real estate

Investing in Residential vs Commercial Real Estate

By 17/06/2021 August 29th, 2022 0 Comments
INVESTING IN RESIDENTIAL VS COMMERCIAL REAL ESTATE

Introduction

Besides investors and real estate developers, a large portion of Pakistan’s society does not understand the differences between residential and commercial real estate. Concerns related to high risks in commercial real estate make people invest significantly more in residential property. It is a major reason why the development of the real estate sector remains focused on housing societies in Pakistan. Depending on factors like time, goals, risk tolerance, and liquid capital, investments in commercial real estate can prove to be much more profitable. Most people have the perception that residential property is more valuable as it is more stable in an economic crisis and one can always rent or utilise it for personal use, whereas the utility of commercial properties is limited by market acceptance of the project. However, commercial properties offer an easier increase in value, higher returns, qualified tenants, and longer lease terms. Continue reading to understand how investments differ in residential and commercial real estate. 

Understanding Residential and Commercial Real Estate

Residential real estate consists of single-family homes, townhouses, apartments, and any built structure with less than five units for consumption (Esajian, 2021). The owner has the option of either living in the space or renting it out to earn income. Residential properties are mostly leased to individuals and families, with some areas having strict regulations regarding conducting business on residential premises. Residential real estate is mostly found in the form of developed societies that offer all the basic municipal amenities, security features, and management services. As the value of real estate largely depends on the physical and socioeconomic characteristics of land, residential real estate will also differ in value according to the living standard offered to the residents. Owning a home also has a significant impact on the social status of an individual, and therefore, people consider residential real estate to be a more fulfilling form of investment in real estate.

On the other hand, commercial real estate is used for non-residential activities and includes places like hotels, office spaces, retail shops, industrial buildings, warehouses, and public facilities (Jasper, 2021). The owner has the option to conduct business on the premises or, like residential real estate, lease out the property to tenants. As companies prefer to rent properties that they operate from as it frees up capital to invest in the core business, the demand for commercial real estate always remains high. Commercial properties are also supported by tenants who produce goods and services to generate income, whereas residential real estate is mostly seen as a non-productive asset (Than Merill, 2021). Commercial real estate is best suited to those investors who plan for long-term profits and are looking for a way to generate passive income. However, Pakistan’s commercial real estate sector remains largely ignored by the public, and only large investors who have sufficient knowledge about the market invest in commercial properties. 

What to Consider while Investing in Residential or Commercial Real Estate

Many people debate whether it is better to invest in residential or commercial real estate. The answer depends on what is the goal of the investor. The budget, area of expertise, time at hand, and risk tolerance are among the major factors which can influence decision-making. Commercial real estate tends to reward investors with higher profits whereas residential property allows the investor to have a more active role in the management (Larson, 2021).

Commercial real estate offers a high rate of return on investment but the risks involved are also greater. Commercial property offers a diverse portfolio as there are a greater number of units to sell or lease. As the number of tenants is also greater, more profits can be earned. Qualified tenants in the commercial sector also stay committed to their business locations for a longer period compared to residential properties where tenants prefer to shift after short terms (KPMG, 2018). As these tenants are backed by large companies, they tend to be more careful about looking after the property. Commercial properties also support triple net leases, which means that the owner only pays the mortgage while the tenant takes care of all the property expenses including property tax. The most significant aspect of commercial property is the determination of property value. Residential real estate is valued in relation to comparables in the market whereas commercial real estate is valued in terms of the income it generates. Therefore, an increase in the value can be anticipated at a much faster rate compared to residential properties, and even before the project starts in some cases.

Contrarily, the most significant benefit of investing in residential property is the considerably less cost of entry. Although commercial real estate loans are easier to obtain because they are based on financial projections of the property, the average person may not have enough savings for the considerably large down payment. Residential properties also do not overwhelm small and medium investors and most people start out investing in residential real estate before moving towards commercial properties. Residential properties also have lax regulations and zoning laws, making the chances of any violations stemming out in the future a remote possibility. Permits and development grants are also easier to obtain in residential real estate. Moreover, considering the large number of people looking to buy and sell a residential estate, investors have no problem rotating multiple homes in a short period. Lastly, residential properties also perform better in economic crises. Businesses are prone to downturns and thus can vacate their premises or go virtual, as was seen in the case of the global pandemic. Housing always remains in demand and with the rise of e-commerce, the sector has lately seen greater growth than the commercial properties sector (Abellera, 2019).

Conclusion

A large portion of Pakistan’s society does not understand the key differences between residential and commercial real estate. People are more likely to invest in residential real estate as it offers a low cost of entry, has a large market, and performs better in an economic crisis. However, commercial properties offer better quality tenants, higher profits on investments, longer lease terms, and more rapid increases in value. All these factors must be kept in mind while deciding which investment option best suits the investor profile. Stay tuned to read more on how investments in residential and commercial real estate are carried out.

Bibliography

Abellera, J. M. (2019, June). Five Advantages to Investing In Residential Real Estate. Retrieved from https://www.withum.com/resources/five-advantages-to-investing-in-residential-real-estate/

Esajian, J. (2021). Commercial Vs Residential Real Estate Investing: Which Strategy Is Right For You? Retrieved from https://www.fortunebuilders.com/commercial-vs-residential-real-estate/

Jasper. (2021). Key Differences Between Residential & Commercial Property. Retrieved from https://www.jasper.io/global/blog/what-are-the-key-differences-between-residential-and-commercial-property

KPMG. (2018). Real estate Leases. Retrieved from https://home.kpmg/xx/en/home/insights/2018/10/leases-real-estate-tenant-accounting-examples-ifrs16-011018.html

Larson, M. (2021). Pros and Cons of Investing in Commercial Real Estate. Retrieved from https://www.nolo.com/legal-encyclopedia/pros-cons-investing-commercial-real-estate.html

Than Merill. (2021). Commercial Vs Residential Real Estate Investing. Retrieved from https://www.thanmerrill.com/commercial-vs-residential-real-estate/

Research Questions

What are the differences between residential and commercial real estate?

What to consider while investing in residential or commercial real estate? 

Key Takeaways

Besides investors and real estate developers, a large portion of Pakistan’s society does not understand the differences between residential and commercial real estate. 

Concerns related to high risks in commercial real estate make people invest significantly more in residential property. 

Depending on factors like time, goals, risk tolerance, and liquid capital, investments in commercial real estate can prove to be a much more profitable venture. 

Commercial properties offer an easier increase in value, higher returns, qualified tenants, and longer lease terms. 

The budget, area of expertise, time at hand, and risk tolerance are among the major significant factors which can influence an investor’s decision.

Commercial real estate tends to reward investors with higher profits whereas residential property allows the investor to have a more active role in the management.

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