Property Investment: Residential or Commercial?
Property investment offers the astute investor excellent returns, as I’ve already laid out here. However, once you start exploring the investment options you will quickly find that there are a huge number of possible property investment strategies. In this article I will weigh up the pro’s and con’s of two very different categories of property investment – residential and commercial.
What is residential property investment?
Typically houses and flats, in which people live individually, as a family or small group of friends. They would describe the place as ‘home’. Generally speaking if the property has a kitchen of some kind it will be classified as residential.
What is commercial property investment?
The field is much wider. It includes what most investors would readily recognise as commercial investment: shops, offices, factories and warehouses. But this sector includes a far broader selection of investments that includes care homes, student property, holiday property, hotels, land, storage, car parking, graveyards and more!
Differences in investment mechanism
Not only is the commercial property sector very widely drawn, the actual investment mechanism can be more varied as well. With residential property investment you typically own the freehold or leasehold title to the property, and you have often taken finance (a mortgage) as part of the cost of purchase.
With commercial property it may be that you own the freehold or leasehold interest, but increasingly there are many investments where you lend money against security – more like a bank – and never actually own the property. And you may not take finance – 100% of your investment comes from your own resources. I call this a structured property investment.
Whilst this might seem confusing at first glance, it can offer the investor many additional benefits including: lower volatility, defined exit date and value, fixed income, hands-off management and much more. In fact this model of investment fits very neatly into the F.R.E.S.H investment concept I recommend you learn more about.
Property investment inside a regulated pension scheme
In the UK, residential property investment is not allowed within a regulated pension scheme. So even if you want to invest in the residential sector, you can’t if your money is inside a pension. This restriction applies to direct ownership of a residential leasehold or freehold title.
However if the investment is structured as a loan, and then the loan is made for residential investment, then that is permissible because the loan is a permitted investment!
Within a pension scheme, all commercial property investment is allowable. So there is enormous scope for property investment within a regulated pension scheme, with the exception of direct residential property investment.
Borrowing for your property investment
One of the great benefits of property investment, where you are seeking maximum capital growth, is the ability to borrow part of the purchase price from a bank and hence leverage the capital you have. This is a powerful proposition with many reasons to recommend it as a strategy.
However, the strategy is absolutely not for everyone. In particular it increases the risks considerably, and reduces cash flow maybe even into negative territory. That’s all fine if you are young, don’t need the income and can afford the time to recover if the market hits a downturn. Not so fine if you are saving for retirement, need the income to grow your fund and you are in a period of zero capital growth!
Choosing residential or commercial property investment?
Which to choose? In a market with so many variables and so many options you won’t be surprised that my answer is not black or white. From my own 30+ years of property investment experience I would say that the two options pan out like this:
|Residential investment||Commercial investment|
|Starting capital needed||£20,000+||£10,000+ (for structured investment)|
|Certainty of income||Medium||High|
|Fixed exit strategy||No||Yes|
|Leverage (not always good!)||Higher||Lower|
|Good for young investors with 20+ years before retirement||Yes||No|
|Good for older investors looking for security, fixed income and low volatility||No||Yes|
Copy a millionaire property investor!
A few years’ back when I was researching my training manual for aspiring property investors I interviewed many property millionaires. One of them contributed heavily at the time to the discussion on the relative merits of residential or commercial property investment.
He, and his partner, had built an enormous portfolio of more than 200 residential properties. When I spoke to him, he was busy moving his investment portfolio into commercial property investments. Why? The reasons he gave were reducing volatility, reducing the ‘hands on’ management, switching from capital growth to income and generally having an easier life.
At the time I noted what he was doing, but ten years later it came back into my mind because it fits so perfectly what I have been trying to express in this article. If you are young, seeking maximum growth in your capital and you don’t mind the hassle of ‘hands-on’ investment, then residential with maximum leverage has much to commend it as a strategy.
But if you are within 5-20 years of retirement, and you want less hassle, more certainty of income and much reduced volatility, then commercial property investment is more likely to deliver what you want.
Do you agree or disagree? Leave your thoughts below.