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Where to invest: in commercial or residential real estate?

Real estate has always been and continues to be a common means of investment, even after such market turmoil that occurred in 2007-09.

Despite the fact that the real estate market has many opportunities for profit, buying and owning real estate can be much more difficult than investing in stocks or bonds. In this article, we will introduce you to some basic rules of real estate investment and compare the profitability and nuances of investing in residential and commercial real estate.

The advantage of real estate investment

In comparison with other types of investments, investing money in real estate protects your funds from inflation. In addition, such investments often do not require the investor to have a deep understanding of the field or special knowledge and experience.

  • By purchasing residential or commercial real estate, you can immediately make a profit by renting an object for rent;
  • Potentially, the income from investing in real estate is higher compared to a bank deposit or government bonds;
  • The real estate market, in most times, tends to increase in value. Often, the real estate market remains the most stable during economic crises. Even in the case of a fall (recall 2008), prices quickly return to their previous level;
  • Even when property prices are falling, the rental price rises;
  • Possessing your own real estate, you can use it as collateral for bank loans, for example, to invest in others.

Of course, real estate investing is not only profitable, but also fraught with risks. Among the negative aspects should be highlighted:

  • Low liquidity. If you urgently need to sell the property, it will take much more time and effort compared to the same securities;
  • Attachment to the place and the weather. Naturally, moving the house will not be easy, even if it is very necessary. This disadvantage follows from the previous one, since in case of damage or destruction of an object as a result of war or natural disaster, you can only rely on insurance;
  • The downward trend in the real estate market over the past years. Therefore, with the current realities, it is difficult to rely on quick speculative earnings.

Investment options for real estate

A potential property owner must clearly understand how his investments will generate future income. In our article we will consider two main options for generating income from investing in a property: renting such an object or selling it at a cost higher than the initial one.

Rental Property

Property rental is a type of investment, as old as land ownership. In fact, you buy a property and lease it to a tenant. From now the owner is the landowner and he responsible for paying the mortgage (if the object is purchased on credit), taxes and property maintenance costs. Ideally, the landowner will charge enough rent to cover all of the above costs, while remaining enough to earn a monthly profit from the start.

However, depending on market conditions, the landlord may have to be patient and set the rental price only enough to cover the costs or even allow minor losses in order not to lose the tenant. Such processes are unpleasant and require some kind of financial cushion to cover periods of loss. In such cases, it must be remembered that landowner tend to invest for the long term and the return on such investments can also be long.

This option is ideal for people with repair skills and the ability to do business with tenants. To start work there will need a significant amount of capital: for the purchase of the object itself, as well as to cover the initial costs of repairs and maintenance.

Investing in real estate for the purpose of renting out can easily become a new source of regular income if the investment is successful. Moreover, many of your expenses are not taxable, and any losses can be offset by profits from other investments.

Of course, monthly property income is not the only goal of the landowner. As with all real estate, property can increase in value over time, leaving the property owner a valuable asset. In this case, the object can be sold or used as collateral for future projects.

Of course, there are negative sides. For example, you may find an unscrupulous tenant who will damage property, or, worse, you may not find it at all. In such a situation, you are left with a negative monthly cash flow. The situation is exacerbated if such a property you purchased in the mortgage. Also, when renting an apartment, say, you should be mentally prepared to pay attention to it and the tenant.

Real Estate Trading

Commercial real estate is the flip side of real estate investment. Real estate traders are a completely different breed than property owner. Real estate dealers buy properties with the intention of keeping them for a short period of time, often no more than three or four months, after which they hope to sell them at a profit. This method is also called property switching and is based on the purchase of objects that are either significantly undervalued or are in a very hot market.

Such real estate trading requires a deeper knowledge of the market and a bit of luck. Hot markets may cool unexpectedly, leaving short-term traders with a loss and a long-term headache. Naturally, decent investment is required for such investments.

Among the obvious advantages it is possible to single out the fact that real estate trading, under favorable conditions, is able to bring significant income even in a short period of time.

What type of property to choose?

In order to receive a stable income from real estate, an investor must be wisely approaching its choice, given its type and location. The first and most obvious is investment in domestic real estate. In particular, in real estate located in major cities, where payback and liquidity are higher. Below is a comparison of cost, payback period and average profitability of residential and commercial real estate.

Apartment

The most common option for investing in real estate is to buy an apartment. A huge role for such an object is played by its location relative to the center, convenient traffic interchange, etc. When buying an apartment from an investor, there is a choice between purchasing an already finished apartment or investing in an object at the construction stage. In this case, you need to properly weigh the pros and cons. After all, when investing in an object that has not yet been completed, an investor can save a lot (up to 50% of the cost), but in proportion to the benefits, risks also increase. Also in the future you will have to do repairs and landscaping your property.

The average cost per square meter of an apartment in Kiev in 2018 was 28 843 hryvnia (about 1 thousand dollars). On this basis, the average cost of a one-room apartment with an area of ​​35 square meters in the capital of Ukraine will be slightly more than a million hryvnia, or about 36 thousand dollars.

At this price it is possible to purchase an apartment on the secondary market in a Soviet-built house. Obviously, such an apartment will be far from the center, but we need a good transport interchange. When analyzing current ads, we were guided by these principles.

As an example, we chose an apartment not far from one of the final metro stations. The apartment has been redecorated, but there is no basic household appliances.

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When buying such an object, you will also need to equip it and bring it into a residential look. From here, with all the costs incurred for the purchase, design, repair and, as in our example, the commission to the realtor, we leave for an estimated amount of 41-44 thousand dollars.

As shown by our search for similar properties offered for rent, to rent such an apartment, with good repairs, furniture and equipment can be approximately 9,000 UAH per month. If we discard the payment of taxes, operating costs and inflation, then such an investment will pay off in 137 months or 11 and a half years.

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To calculate the profitability of such an investment, we used a simple formula:

(Annual rental price Maintenance costs) / Total cost of the apartment * 100%

The maintenance costs include expenses for repair, installation of an intercom, etc. As we wrote above, in our calculation we discarded such expenses. Therefore, after simple calculations, we come to the fact that the profitability of our investments is 8.7% in UAH.

With the current average rate of 13% on bank deposits, we conclude that such an investment has too low a return.

Commercial real estate

I think everyone understands that the average cost of commercial real estate is much higher than residential. However, the difference between rental income is appropriate. Many analysts and managers agree that commercial real estate brings twice as much income to investors.

Also, a significant advantage would be that dealing with tenants of commercial property is often less problematic than with tenants of housing. The tenant of commercial real estate will do most of the work that will have to be done in the event of the rental of residential premises.

With a typical rental period, which is usually 12-18 months, residential real estate can be much more demanding. Worn property, stains on the walls and ceiling. Not to mention all the costs of repairs and maintenance during the year. Commercial real estate is less whimsical in this regard. Yes, and tenants remain for a longer period compared with residential real estate.

However, less than five percent of commercial property is owned by individuals. Mostly owned organizations, groups of people or property funds. Perhaps the statistics is precisely because of the high cost. Not everyone has the opportunity to acquire such an asset. Naturally, there are enough offers on the market for objects of the same price category as our apartment example. However, you should understand that with a budget of up to 40 50 thousand dollars investment in real estate from the category of commercial does not seem attractive or more profitable.

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As an example, we found an object for sale at approximately the same price as the apartment being analyzed. Such an object will cost the investor 4-5 thousand more expensive, and this is taking into account the fact that the room is without any repairs. The location is also not very convenient, and it is obvious that for such an object it will be more difficult to find a tenant.

Therefore, we conclude that if there is an amount of 30-45 thousand dollars at the moment, it will be more profitable to purchase a residential property. Naturally, provided that the average yield will be higher than the market average. Otherwise, it will be much easier and more profitable to deposit money.

Conclusion

It can not be denied that investing in real estate is not an easy path with a lot of pitfalls. To purchase will have to spend money.

Working with residential real estate is considered more laborious and risky. However, it is capable of generating income with a smaller investment bag. People who are thinking about investing in commercial real estate are likely to get more income with fewer problems. But this will require much more money.

Remember, real estate investing is a long-term investment. If you approach this issue correctly and carefully study the condition of the real estate market, successfully select objects, then the risks of losing your capital will be minimized.

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