Residential or commercial: which property investment is best?

Real estate investors have two main choices: residential and commercial property. Generally, residential property is considered best for first-time real estate investors, while commercial property is perceived as more suitable for experienced investors with a larger budget such as portfolio owners, companies, financial institutions, pension organisations and sovereign wealth funds.

Many “ordinary” investors consider apartments and villas easiest to understand and manage. Often, people will buy a unit in a city or neighbourhood that they know and trust. They may view the investment as a possible future home, retirement property or student accommodation for their own children. Residential values and rents are generally easy to follow and purchasers feel that they can easily keep an eye on how their investment is performing.

However, residential property investment does present its challenges: rental terms can be short and turnover of tenants can be high. Additionally, residential tenants often have reduced responsibility for matters such as upkeep and insurance, when compared to commercial property tenants. There are tales of residential tenants surrendering a property in terrible condition with little or no indemnity afforded to the landlord, other than a month or two in security deposits.

Commercial property

By comparison, commercial property is generally occupied by a company. Lease terms are longer, rent review periods are clearly defined (often upward only) and all details are normally set out in much more comprehensive commercial lease agreements. This affords owners the ability to better plan for the medium to long-term direction of their investment. Tenant Covenant, the perceived strength of the lessee, is another benefit to a commercial property landlord, particularly if the tenant is a reputable company that is less likely to default on rental payments.

Of course, landlord and tenant problems could still arise, but on the whole they are dealt with in a more business-like fashion, with recourse to third-party experts normally set out in advance. In return, investors in commercial real estate generally enjoy being less hands-on, with more responsibility for the upkeep and protection of the property passed to the tenant.

However, commercial property often feels the negative effects of an economic downturn first and can take longer to recover than the residential segment. Also, entry-level prices can be higher and purchaser deposits are larger, as banks generally apply lower loan-to-value (LTV) mortgage ratios to commercial property.

Banks will also often only lend on shorter terms and at higher interest rates than with residential buy-to-rent loans. Rent-free periods and contributions to tenant fit-outs are other costs that commercial landlords are more likely to face.

Generally, commercial property is of a price level and size that only larger corporate entities can consider for acquisition. However, opportunities do exist in Dubai for smaller-scale property investors who are considering balancing their residential portfolio with commercial offerings.

Those who don’t have significant funds for large-scale commercial property acquisition can consider entering the commercial real estate market by acquiring single-unit office suites or small retail units. Opportunities also exist to buy single hotel suites in premium hospitality offerings, with the overall operation to be run by a hotel operator and a hands-off return enjoyed by the purchaser. These property types present real opportunities for single purchasers wanting to move into non-residential property investments for portfolio diversification.

Commercial property sales rates appear to represent good value in some Dubai locations. Such locations could be considered potential candidates for future price growth as the Dubai economy grows, service sectors expand and employment increases.

Investor requirements

Moreover, impressive price rises with apartments and villas, coupled with rising rental incomes, present a very strong case for residential investment in much of Dubai and Abu Dhabi.

An investor’s requirements help indicate which property type is most suitable for a particular purchaser. Are they seeking security of capital with solid rental income and less focus on future price growth? Or are they chasing increasing asset values with less focus on regular income? Asset liquidity should also be of note to an investor: if they had to sell the premises quickly and convert to cash, how long would it take? Would the property likely have a very wide pool of available buyers and sell quickly or be in a smaller, more specialised market?

Both residential and commercial properties currently offer attractive propositions in many parts of Dubai and Abu Dhabi. However, an investor’s individual criteria and investment requirements will ultimately indicate which property type is most suitable.