Even though the real estate sector has been sluggish over the past few years, the improvement in the overall macroeconomic scenario in India has rekindled investor interest, particularly for commercial real estate. If you are considering investing in the realty sector to profit from capital value appreciation and rental income, you will have to choose between residential and commercial real estate.
Apart from factoring in the overall macroeconomic picture, you must recognise your financial needs and expectations and only then look at the advantages and disadvantages of these two investment avenues. Here are some key aspects to consider before choosing.
Financing: It is easier to get finance for a residential property. Loan for as much as 90% of the property value in some cases is available from banks and housing finance companies. The interest rate is also competitive. On the other hand, securing a loan to buy a commercial property is more difficult and you can get finance for only up to 60% of the property value. The interest rate is also much higher, thereby making buying commercial real estate more capital intensive. Thus, this category is more suited if you have capital available. If you have limited funds, then investing in a residential property should be the preferred option.You can avail a long-term loan and structure the deal for a minimal monthly outgo from your pocket.
Tax advantage: Unlike commercial properties, which get no tax breaks on principal or interest repayments, investors of residential real estate can avail an array of tax benefits. For self-occupied properties, there is tax deduction of Rs.1.5 lakh available under section 80C of the income tax Act for payments made towards principal repayment and up to Rs.2 lakh on interest payments, under section 24. Additionally, for investment in affordable housing schemes, under section 80EE, Budget 2016 has proposed an increase in the tax benefits from the present Rs.1 lakh to Rs.1.5 lakh. But this increase in interest deduction will be applicable only for first-time home buyers and on loans not exceeding Rs.35 lakh for homes costing below Rs.50 lakh, and sanctioned in 2016-17 (April-March).
Rental returns: Commercial real estate can be a better source of regular rental income with rental yields of 8-11% against 2-4% from residential property. Also, unlike residential real estate that could be untenanted for a long period, upkeep of commercial property is easier and requires limited operational management because such properties are typically taken care of by professional project maintenance agencies. Investors do not need to spend on the furnishings either. The tenants generally design the interiors of commercial properties as per business requirements and bear the costs involved. Also, longer term lease agreements, like a 3+3+3 year pact with a pre-determined rent appreciation, are made when leasing commercial space, whereas for a residential property, shorter-term leases are preferred.
Selling the property: When it comes to exiting or liquidating any real estate asset, finding the right buyer can be a slow and difficult process. In commercial property, the economy’s cycle also comes into play. For example, if you have invested in a commercial space that caters to a specific industry which has slowed down, selling the property can be difficult. In such situations, it may be difficult to get new occupants or renew the lease. One may even have to compromise on the rent. Understanding these risks before investing in a commercial property is crucial. But there is a possibility to part-sell a commercial property, which you can’t do with a residential unit.
Loan against property: You can leverage on your real estate investments by taking a loan against property (LAP). The LAP ratio is close to 65% for residential properties and about 55% for a commercial property.
If you already own a house or you are a seasoned, deep-pocketed investor looking for higher return on investment, you could explore the commercial property option. But if you are a first-time buyer or have low capital yet want to benefit from investing in the sector, then till the option of investing in commercial real estate through REITs (real estate investment trusts) is made available in India, opting for a residential property would be your best bet. You can obtain cheaper finance and avail various tax benefits.
V. Srinivasan, business head, CRISIL Ratings-SME and real estate.
Credits Live Mint