Property investment - commercial vs residential

POSTED: 1st September 2014
IN: Personal Guides

Property is traditionally a popular asset class in the UK and will continue to attract interest from investors in the future.

Property is traditionally a popular asset class in the UK and will continue to attract interest from investors in the future.

An increasing number of individuals and businesses will currently be turning their attention to investment options in a bid to make the most of improving economic conditions.undefined

One key question to answer is what sort of property to go for - commercial or residential.

Before making this decision, it is important to do some research on both sectors and develop an understanding of the differences between them, as well as factors such as prices and tenant demand.

Commercial property

Research suggests that commercial property investment has been a profitable endeavour so far in 2014, with the market benefiting from wider trends of economic growth and business optimism.

A report from consultancy group CBRE covering the second quarter of the year showed ongoing increases in the two main income streams from commercial property - rental values and capital growth.

The findings highlighted average prime rental yields of 5.7 per cent at the end of Q2, which was slightly down on the two preceding quarters. Capital values at the 'all property' level rose by 3.8 per cent over the second quarter, contributing to 6.8 per cent capital growth during the first half of the year.

Separate research from another property consultancy, Lambert Smith Hampton, revealed that investment in UK commercial real estate totalled £11.9 billion in the second quarter of 2014. This is a ten per cent increase from the first quarter and 45 per cent up on the same period last year.

Ezra Nahome, chief executive of the company, said: "The pick-up and shift in investment activity over the last few months means we have seen a fundamental change in the market: deal volumes are up; investors, especially UK institutions, are much more active in the regions; and prices outside London are now on the rise."

While there are clearly some positive trends to take advantage of in the commercial property market, investors should also be aware of the drawbacks of this asset class in comparison with residential property.

The first consideration is cost. While some commercial sites, like independent shops and small offices, may be comparable in price to houses, larger premises will have much higher price tags. Smaller investors interested in assets such as shopping centres, office blocks or industrial complexes will probably have to go through collective investment schemes.

Linked to this is the issue of valuation. There can be great variation between properties in the commercial sector, meaning it is difficult for investors to assess values without seeking professional advice.

It is also important to be aware of issues such as the regulations surrounding commercial property, the higher costs involved in setting up mortgages and the market's vulnerability to economic factors.

On the positive side, commercial leases tend to be longer than residential leases, and sometimes contain clauses stating that rent reviews are 'upward only', meaning the rent paid on a property cannot go down.

Another advantage of commercial property investment is that tenants, rather than owners, are generally responsible for covering the cost of repairs and maintenance.

Residential property

Rental income is a much bigger factor for commercial property investors than those buying residential property. According to Reita, an initiative run by the British Property Federation, average rental yields from commercial premises between 2002 and 2007 were about 50 per cent higher than from residential assets.

For this reason, capital growth, or increases in the value of property, is a major consideration for residential investors. There has been plenty of good news in this regard over the past year or so, with house prices rising consistently. Further increases are expected in the near future, partly as a result of the imbalance between low supply of new housing and high demand from would-be buyers.

Residential property investors have a good chance of seeing value growth in the years to come, but in the meantime, buy-to-let mortgage holders will be reliant on rental income. There has been cause for optimism on this topic as well, with the latest HomeLet Rental Index showing that the average UK rent for tenancies starting in May 2014 was £846 per month, which is 7.5 per cent higher than a year earlier.

Martin Totty, chief executive of Barbon Insurance Group, said the private rental sector is continuing to see strong demand, with growth in average rents and the typical incomes of tenants providing good news for landlords.

However, prospective residential investors need to take into account the potential drawbacks of the market. One consideration is that residential property is likely to place more demand on your time than commercial investment, because of the shorter lease lengths and the landlord's obligation for upkeep and repairs.

Looking after the property is also a major financial concern, with maintenance costs sometimes absorbing more than 30 per cent of an owner's rental income, according to Reita.

Shorter leases in the residential market can also heighten the risk of voids - periods during which your property is unoccupied.

All things considered, it seems that both the commercial and residential property sectors are currently offering bright prospects for investors. The decision of what market to choose is likely to be determined by individual circumstances and preferences, with regards to issues such as how much to invest, personal involvement in the project and exposure to risk.

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