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Real estate investments: Residential or commercial?

Real estate investments: Residential or commercial?.

The private residential market, which has been soft for some time, is stirring to life again, as new home sales more than doubled in October while resale volumes rose by 15.7 per cent in the third quarter. Meanwhile, in the office market, rents are showing signs of bottoming out. With these developments hinting at emerging investment opportunities in the real estate market, many aspiring investors will ask: “What type of property should I invest in?”

There is no one-size-fits-all answer, as different asset classes carry different characteristics and trend differently in different markets, appealing to different investment objectives, capital outlays and risk appetites.

Capital outlay and financing

For a start, the individual’s financial health will, by and large, determine the maximum capital outlay, which in turn will determine the viable investment option. Residential property tends to require a smaller capital outlay. While some commercial properties such as small offices or independent shop space may be comparably priced against houses, larger ones often carry a heftier price tag. A higher cost of investment may require additional financing or a collective pool of funds.

Financing regulations for residential properties are generally less complex than those for commercial properties. Lending policies for different asset classes also vary from bank to bank, which affects the ease of getting a loan.

Loan tenure is also a key consideration: The loan tenure for commercial properties is typically shorter than that for residential properties, which will have an impact on the required cash outlay and the monthly repayment sum.

Current market conditions

Another important point to consider is the existing condition of the market segment one is looking to invest in, as this will determine the risks and returns.

Statistics from the Urban Redevelopment Authority indicate it is now easier to find tenants for private residential units than for office space. Vacancy rates for private homes are generally below 8 per cent and have not exceeded 9 per cent since the fourth quarter of 2011, while vacancy rates for offices have been hovering around 10 per cent between the fourth quarter of 2011 and the third quarter of 2016, and have not fallen below 8 per cent during the same period.

While it may seem like Singapore’s commercial property market is experiencing a glut, this could offer a low barrier of entry for investors with a long-term view. As expected in a property market down cycle, capital values of prime offices will weaken, and this may present investors with an opportunity to enter the market for higher capital gains later.

Risk vs expected returns

That brings us to the expected returns on investment, which come in the form of rental yields and capital gains. Commercial tenants typically pay higher rents and are more reliable in making rental payments than residential ones. Furthermore, since commercial space is normally leased out for a longer duration — between three and five years, compared with between six months and two years for residential properties, the investor is assured of regular rental income over a longer period of time.

The downside is the longer time that the investor takes to react to market conditions via tenancy renewal. Another point to note is that commercial properties are generally more sensitive to economic conditions than residential properties. For investors who prefer to sell the property and make a capital gain when the value appreciates, residential properties may be a safer bet, as prices can change substantially in a relatively short period of three to five years.

However, with the current dismal economic conditions, making a good profit through capital gain is likely to take a longer time. The investor may have to lease out the premises while waiting for the right opportunity to sell. Leasing demand for the type of property as well as the financial commitments of the investor are important considerations.

Maintenance obligations

Another consideration that is sometimes overlooked is the maintenance obligation under a rental arrangement. Tenants of commercial properties are usually responsible for these costs, while the costs of maintenance or renovation of residential premises are usually borne by the landlord, which can have a substantial bearing on the investor’s rental income. The attractiveness of real estate investment remains even in the face of a more subdued economy. Whether commercial property or residential property makes a better option depends on more than the desired return. The investor needs to balance that with his or her financial health and risk profile in light of prevailing market conditions.

Regardless of the type of property, investors should always carefully weigh their options through research, and analyse the opportunities that come their way. A new investor may also engage a reliable agent to help him or her on the real estate investment journey.

Adapted from: TODAY, 23 December 2016