One of the most popular ways of earning returns in real estate is through leasing and rental yields. People have conventionally sought real estate investments for their ability to produce passive income through leasing the property. Real estate investments are generally undertaken in residential or commercial properties. Though both the options are quite attractive, there exists a certain degree of confusion among the investors about which type of real estate investment is more profitable. It is essential to know the potential risks and returns of both residential as well as commercial properties and their income-generating capacity before taking the final call of investing your money in them.
In this article, we seek to address the reasons favouring residential or commercial properties for their rental generating yields and their overall return on investment for the long-term.
7 Aspects Influencing the rental yield of residential and commercial properties
There are several aspects that determine the rental yield of a property. With investing in a property complying with these factors, one can ensure a higher rental yield on the same. These aspects are as follows:
One of the major factors that decide the rent of a property for both residential and commercial spaces is the location. Premium locations with high connectivity through metros, airports, public transport, and so on, attract higher rental prices. For residential properties, the location must be central to various amenities like shopping malls, metro and railway stations, grocery markets, restaurants, among others. For commercial properties, the location must be in or around the Special Economic Zones, Central Business Districts, Business Parks, Factories, and so on.
Area under usage
The carpet usable area also plays a distinguishing factor to increase or decrease the rent. In residential properties, as the number of BHK increases, the rent tends to increase in the same fashion within a particular locality. For commercial property, rent per sq. ft is decided along with any fit-out cost incurred for interior developments.
Age of the built property
The age of the property is somewhat inversely proportional to the rent. This is due to the architectural inefficiencies that are caused over time due to the natural environments of rainwater causing the structure to lose its strength. This factor majorly impacts residential properties as people prefer to live in new well-built properties than old and weakly structured ones.
Maintenance and Tax Costs
The rent of the property includes the maintenance costs and municipal property taxes, water taxes, and so on. These costs usually depend on the locality within which the property is situated. A premium locality will demand higher rates on maintenance and other taxes thereby increasing the overall rent. Generally, commercial properties have a higher tax rate than residential properties.
Rental Escalations per annum
Rental escalations happen every year for residential properties and commercial properties. These escalations are generally in the range of up to 5 to 7 per cent for residential properties and 2 to 5 per cent for commercial properties annually. Furthermore, the Draft Model Tenancy Act of 2019 proposes to regulate the percentage rent escalations by the landlord by setting a maximum cap of 10% and the states further deciding their cap rates as per the Centre’s guidelines.
Legal compliance for Title
A legally complied property has a higher worth than an illegal one. Thus, some increase is reflected for legally complied properties that have a clear title. This applies to both residential as well as commercial properties.
Usually, residential properties have 11-month lease agreements. But for commercial properties, the lease period usually varies from 3 or 5 years. So, for a shorter period, commercial lease rents are higher and for a longer period, the rent is higher. But for residential properties, this period is fixed which is 11 months. Renewal can be done with another agreement for the next term.
The above factors play a key role in deciding the rental yield from the residential and commercial properties. With optimization of these factors, an investor creates a potential opportunity of earning higher rents on the property.
After understanding the factors determining the rent, it is also important to know which kind of property provides a higher return on investment and which properties are more suitable for the investors’ goal.
Difference between Residential and Commercial Properties
Residential properties have comparatively lower prices.
Commercial properties have higher prices in the same locality as compared to residential ones.
Higher leverage options are available for purchase due to more demand. Also, interest costs for residential or home loans are lower.
Lesser leverage options available and interest on loans is generally higher as compared to residential properties.
Tenure of Lease
Generally, an 11-month tenure is the market practice for residential properties.
A period of 3 or 5 years lease is common in commercial properties in India
Higher volatility due to frequent changes in tenants and may succumb to demand lulls.
Lower volatility due to higher lease tenure.
Average Rental Yield
3 to 5 per cent per annum.
6 to 10 per cent per annum
Tax on Rental Yield
Taxed as per slab rates.
However, interest on a home loan for let-out property can be deducted under Sec 24b
Taxed as per slab rates.
However, interest on commercial property loan on the let-out property can be deducted under Sec 24b
The landlord bears the maintenance and property tax cost for the Residential Let-out property
The tenant bears the maintenance cost for commercial let-out property and the landlord bears the property taxes.
This detailed comparison of residential and commercial properties is useful for investors who are set to make their real estate investments. Rental income is a major component of real estate investments. To attract maximum gains, commercial properties fare better than residential properties. However, taking the initial capital requirements, commercial properties are much costlier than residential properties. Thus, the investor can take into account all the factors, and depending upon the capacity of his/her investment, the investor can choose between residential or commercial properties.
For investors who eagerly want to invest in commercial properties but lack capital, fractional ownership options can prove to be a better real estate investment for them. With fewer funds, only part ownership in the commercial property can be owned. Assetmonk provides fractional ownership real estate investments through specially curated options like Growth, Growth Plus, and Yield Models for maximum benefits.
Residential Vs. Commercial Properties which offers best Rental Income FAQ's:
Any type of residential or commercial property which includes apartment flats, bungalows, plots, condos, Office spaces, small shops, commercial market places, malls, hotels, resorts, and so on, can be rented out to derive rental income.
Residential rental income is taxed under Income from House Property with deductions of flat 30% of NAV and Interest on property loan under Sec 24 a and b of Income Tax Act.
Income from a rental property is shown under the head Income from House Property under Direct Income Tax.
One cannot avoid paying tax on rental income. However, the deductions of an Interest payment can be claimed if the property is purchased on loan.
Yes, owning a rental property provides a consistent stream of rental cash flows and the capital appreciation of the property gives a much higher value at the time of sale.