What Is A Better Investment, Residential Property Or Commercial Property?

After the announcement of Brexit in 2016, the pound sterling dropped by ~13% opening new opportunities for both residential and commercial property investors.

It’s been an uproar that residential buy-to-let industry is dead. Whilst other investors are worried about the decline of commercial properties due to the shift of the economy online.

To help you gauge the investment potential and your level of risk tolerance to each property, here’s a granular look on each factor.

Property Investment Advice

To grow your investment within the property market you must be able to:

  • Research, identify and purchase grossly under-priced properties.
  • Outperform the gross inflation rate of the currency.
  • Have the ability to recycle your earnings into other property assets or revenue streams.

However if you’re a first time investor, commercial properties can often be too expensive in comparison to residential properties.

This is because commercial properties require more on-site maintenance and often have larger plots of land compared to residential properties.

 

Commercial Properties

Pros

  • Longer lease terms that equates to more stable flow of income.
  • Higher income potential between 6% – 12%.
  • Triple net leases that allows tenants to shoulder incidental costs like maintenance, tax etc.
  • Commercial real property can have ‘forced appreciation’ by driving the business to produce more income.
  • More relaxed taxes than buy-to-let residential properties.
  • A good choice of investment for those who love focusing on the numbers.
  • Less competition due to require a large upfront investment.
  • Limited hours of operation of businesses, which allows you to sleep in peace.

Cons

  • Commercial property value is dependent on the performance of the business.
  • An investment that’s sensitive with the economy.
  • A big investment that requires bigger deposit for the security of the lender.
  • It would be harder to get funding for startups. Lenders may require some financial background and other assets before lending you a capital.
  • Vulnerability of tenant businesses like instances of bankruptcy.
  • The uncertainty of tenancy due to a booming e-commerce industry.
  • Longer lease negotiations that may take 3 to 6 months.
  • May require professional help with the management like property manager.

 

Residential Properties

Pros

  • Stable demand because of the growing rental culture in UK.
  • Financing options are widely available.
  • Vacancy can be less but depends on the location.
  • Lower risks because the properties only depend on the demand of tenants.
  • Easier to acquire because of lower value than commercial properties.
  • Renovations can elevate the property’s value.
  • Residential properties can provide more security for the long-term.

Cons

  • It’s more of an emotional investment and will be dependent on the tenant’s behavior.
  • Maintenance are solely performed by the owner.
  • Tax is at 3% when purchasing a buy-to-let.
  • Leases are short-term starting 6 months to a year.
  • Instances of non-paying tenants which can be crucial if you only have one rental property
  • Residential property value can also fall depending on the selling price of the houses within its area.

 

Financing Options for Commercial Properties

If you’re a risk-comfortable investor, here are 5 ways to help you finance your first commercial property:

Commercial mortgages

Investors can loan up to 55% Gross Development Value(GDV). Existing business owners often have a high rate of capital approval from lenders.

The usual requirements to secure a loan approval are:

  • Deposit of 20% – 30% of the total amount of the property.
  • You’re a homeowner.
  • Must have owned residential or commercial buy-to-let for 2 years.
  • You have bank savings.
  • Proof of income.

Commercial bridging loans 

This is a suitable option if you wish to purchase a commercial property that needs repairing. It is a short term financial relief to help your property to qualify for a more permanent financing scheme.

Features of a bridging loan:

  • The borrower can pay up from 6 months to 3 years.
  • The loan amount is based on the improved value of the property
  • The property doesn’t have to be owner-occupied.

Mezzanine financing

This funding option is a high-risk debt that will cover the remaining amount between your equity and a principal sponsor. Simply put, it’s the funding that will complete your property purchase.

You as the borrower will usually pay up 10%. The other 65% will be shouldered by a principal sponsor. The remaining 25% will be where mezzanine financing takes its place.

 

Mezzanine financing is still considered by investors in spite of being a high risk option. It is proven to provide great returns which makes it worth the gamble with 12% – 20% rate per year.

Hard Money Lenders

This type of financing is not that popular in the UK. Only private lenders consider this business, unlike in the US where there are hard money companies.

This works by having your high value property as collateral. The lender will give up 70% of the value of the property as collateral, it’s a short-term financing scheme that lasts at a maximum of three years.

However, hard money financing usually have higher interest rates. So make sure to have it as your last resort.

Public sector programs

These schemes in simpler terms are like public-private partnerships where both parties benefit from the endeavour. The usual undertaking for this funding are big projects like that of a hospital. Here are the programs available in the UK:

  • Private Finance Initiative
  • Private Developer Scheme
  • Leasehold
  • Crown Build

 

Financing Options for Residential Properties

As for residential property, funding options are more relaxed. The SDLT funding scheme is widely available and encouraged, especially within the emerging letting style called HMO or House for Multiple Occupation.

Below are a list of all of the potential residential funding options:

  1. Buy-to-Let Mortgages – Compared to a residential property that you’ll believing in, a buy-to-let home has more risks. Given all the landlord headaches, lenders don’t have much guarantee. In consequence, they require higher deposit of up to 25% of the property value or the loan will have a higher interest rate.
    There are types of residential mortgage, namely: fixed rate mortgage, interest only mortgage standard variable rate mortgage. Most investors consider the interest only mortgage, this is because you’ll only be paying for the interest over the course of the term and pay the loaned amount at the end of it.
  2. Property crowdfunding – This funding scheme allows a group of people to pool their funds to buy a property. You can pursue this option with your friends or people that you trust the most.
  3. Hard Money/ Private lenders – Just like with commercial properties, there are also hard money lenders for residential properties. It’s also short-term and requires a valued property as collateral.

Note: Landlord insurance is one of the things that you should also consider. It is to secure your property when circumstances are tough and out of control.

 

Stamp Land Duty Tax (SDLT)

Tax has been one of the turning points for investors after the 2016 Brexit. If you’re a first time investor, here are the significant changes that you should be aware of:

  • Tax has been increased by 3% when buying a property.
  • Tax of the property income comes first instead of mortgage costs.
  • Mortgage Interest Relief has been abolished.

Here’s a table to show how tax can cost by the value of the property:

Property ValueUsual SDLT Rate(%)Buy to let SDLT Rate(%)
£0 to £125k03
£125k to £250k25
£250k to £925k58
£925k to £1.5 million1013
£1.5 million1215

Residential Property Tax Implications

Because of the changes above, traditional residential buy-to-let investors are losing the appetite because of the decrease in their income. Now, there’s a significant shift to commercial properties among investors.

However, tax relief is still available residential for property investors which includes:

  • Replacement of domestic items relief (beds, sofas etc.).
  • Property allowance (first £1000 of your rental income).
  • Capital Gains Tax (furnished holiday lettings).

Residential property income exceeding £2,500 is also liable to tax deduction. At this point, commercial properties are at an advantage because of the more relaxed taxation rules mildly untapped by Brexit. To know more about this, click here.

 

The Market and ROI Avenues

The UK’s culture of owning their own home has declined over the years. With currency and property inflation at hand, the demand for rental houses continues to grow.

Commercial Properties

As for commercial properties, a new wave of investment is starting to take place. Here are some important trends to consider:

  1. Physical shops are turning into warehouses for online shops. Since most of the retail industry has now shifted online, a lot of high street shops are vacant. So owners are selling them rather than leaving the property vacant.
  2. Offices are being transformed into co-working spaces. The rise of home-based worker is opening a new market of co-working spaces where they can perform their job remotely.
  3. Industrial spaces to export warehouses. Since the fall of the pound in 2016, the export industry has shown great opportunities to the local manufacturers.

Residential Properties

By using new strategies within the rental market you can make the most of your residential property. Here are some trends that show a lot of potential:

  1. Building new build homes to sell on to the end consumer.
  2. HMO( Homes on multiple occupancy) – As Jim Haliburton a.k.a HMO Daddy predicts that HMO is the most profitable model of buy-to-let.

 

Maintenance Costs

Residential Properties

It’s no secret that there are a lot of tenant horror stories on rental flats in London. So, you should know beforehand that in residential properties, it’s your job to make the place worth living. To give you a more detailed information on the tasks, click here.

If you have one buy-to-let property, you may manage the maintenance on your own.

Commercial Properties

Commercial property leases holds a good delegation of tasks between the landlord and the business. Thus, making it an advantage over residential properties. This setup happens with the following types of contracts:

  1. Net Lease (property tax + base rent).
  2. Double Net Lease – (base rent + 2 incidental expenses(property tax, insurance, utilities, maintenance, and repairs).
  3. Triple Net Lease – Tenant shoulders everything from tax to repairs.

With bigger or multiple properties are involved, it’s wiser to hire a property manager to handle the work.

Value appreciation

What makes real estate a good investment is its value grows over time. Aside from time, residential properties’ value is relative to the value of the local housing market. Also, the progress in the location can also greatly impact its value.

Commercial Property

On the other hand, commercial property is valued by the income of the business renting it.

So some investors force the property value by improving the business’ income generation.

Ideal to your personality

Purchasing residential property can often be an emotional investment. This means the what home is bought can be greatly influenced by how your home makes the tenant or buyer feel.

If you have a transactional perspective on things and loves numbers, commercial property is the way to go. Negotiations only goes are more leaning to bigger returns.

Regardless of what the place looks like, if the returns are promising, businesses will take it.

You can get the best advantage with location and the nature of business that will take place on your commercial property.

Final Thoughts

Real estate will always be a good investment. Regardless of the economy and demand, income can get smaller but the value remains. Just as how John Stuart Mill takes it:” Landlords grow rich in their sleep”.

To know exactly what’s the most suitable property investment is to look within your personal preferences. Start with your investment style. Then set your own personal investment criteria. Once you figured out those two factors, you’ll eventually know what to choose.

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