Authored by Siddharth Maurya, Resource Specialist – Real Estate and Fund Management
Amongst the investment options available such as a fixed deposit, gold, mutual funds and PPF, people still consider real estate or property investment as one of the safest ones. Being one of the few tangible investment options around, real estate is still the most trusted one.
The opportunity cost of realty investment in comparison to other instruments is favourable. Real estate as a tangible asset class is less volatile when compared to equities. Despite a heavy toll due to a multitude of factors, the real estate segment, especially the residential realty segment, has withstood the pressure of time and is an ideal investment class for medium and low-risk appetite investors.
However, when they say, the land is the best investment option on the earth; they fail to specify the type. Residential or commercial? This is the million-dollar question a property investor, aiming to earn a rental income, asks before putting his hard-earned money in real estate. Honestly speaking, both residential and commercial property investments come with their own set of pros and cons. Let us analyse in greater detail.
Residential investment for rental income
The investors are primarily driven towards investing in residential properties and earning a rental income out of them. There are a multitude of factors behind this trend such as easier acquisition or construction of a residential property, lesser approvals, faster clearances, comparatively lower initial investment and easier resale. Moreover, residential properties are likely to get tenants faster than their commercial counterparts.
However, if we look at the historical ROI, rental returns from the residential property are way lower as compared to commercial properties. Rental returns from residential properties can be pegged at 2 percent per annum on an average.
Let us try to understand by an example, a luxury 3 BHK flat of Rs 2.5 crore in an upscale locality of Gurgaon is likely to fetch rentals at Rs 40,000 to 42,000 per month or Rs 4,80,000 to 5,04,000 lakh annually. In addition to this, the rate of appreciation is hugely dependent on a range of factors such as location, presence of physical and social amenities, city and connectivity quotient of the region.
A key advantage for residential property is that the maintenance cost is far lesser in comparison to large commercial properties. It is an important factor as these charges can eat up a significant part of the rental income earned from property investment. If the budget is low, it is better to go for a residential property.
Commercial realty investment
The commercial properties generally include shops, offices, warehouses, Godowns and showrooms among others.
In comparison to the residential property investment, the commercial properties have a high rental yield. The rental returns from commercial property investment can be pegged at over 8 percent per annum.
Although commercial property investment attracts a large initial sum as compared to residential properties, the attractive rental returns compensate for the initial investment blues. If the rental returns are understood from an example, a 429 sq ft shop in Gurgaon, priced at Rs 35,000 per sq ft will fetch a rent of Rs 1, 07, 250 per month or over Rs 12 lakh per annum.
In addition to this, the rate of appreciation of commercial real estate is faster in comparison to residential properties. However, a dampening factor can be a high maintenance cost. It can range up to Rs 7-12 per sq ft per month, depending upon the type of property. Moreover, the lease or rent agreements of commercial properties are generally long term, leaving little room for frequent change of tenants and rent negotiations. They prove to be a consistent source of rental income than residential investment.
Conclusively, if the budget is low, maintenance capacity is poor and frequent change of tenants is not an issue, an investment into the residential realty segment is suggested. However, if budget is not a constraint, the commercial real estate investment will yield far better and faster returns than a residential flat or villa. The investors must use discretion and consider all the factors such as budget, amenities and connectivity, security and presence of markets before investing their hard-earned money into a property business for rental income.