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Residential vs commercial

What are the differences between investing in residential property and commercial property?

The first difference is that commercial property tends to cost many times the price of residential property. Although it is possible to buy small, individual shops and offices at prices that are comparable with those of residential properties, the cost of large, high-quality commercial properties, such as shopping centres, office blocks or large industrial premises, may run into hundreds of millions of pounds. As such, for most personal investors, collective investment schemes represent the only way to gain exposure to commercial property.

Secondly, the uniqueness of most commercial properties outside of high street shops or industrial warehouses makes it difficult for investors to get an accurate valuation without access to professional advice. By contrast, it's relatively easy for residential investors to compare the prices of houses or flats in a given area, based on comparable market activity. Professional, technical advice is crucial for anyone considering direct investment in commercial property.

Thirdly, the lease between landlord and tenant varies significantly between the commercial and the residential markets, particularly given the following:

  • Commercial leases tend to last much longer than residential leases - five years or more versus an average of one year (although residential leases tend to be more readily renewable). However, residential property can often entail a higher level of voids than commercial property because of the shorter lease period.
  • Commercial property leases have traditionally contained clauses dictating that rent reviews are 'upward only', meaning a property's rent can't be less after review than it was before review.
  • The legislation surrounding landlord and tenant relationships is different for commercial and residential leases.
  • The responsibilities for repairs and maintenance are different; in commercial properties tenants are typically responsible for these costs, while in residential properties landlords are typically responsible. For landlords of residential properties, these costs can absorb much of their rental income - perhaps more than 30% in some cases.

Residential property is also likely to require more management time (and/or cost) than commercial property. This is because of smaller unit sizes, shorter lease lengths, and a greater obligation for maintenance and repairs.

Finally, the make up of income is different for commercial and residential properties. For commercial landlords, the income from rent is a much greater factor than for residential landlords. In fact, over the period 2002-2007 the average rental income from commercial property investment (expressed as a yield) was about 50% greater than from residential property. For residential landlords - both institutional and retail - there is a need to regularly sell a proportion of their properties in order to realise the increase in capital values to supplement the income from rental.

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This guide is supported by the Investment Property Forum Educational Trust (IPFET) in partnership with Reita