February 16th, 2015.
Residential Lease vs. Commercial: Which Is Better?
You’ve chosen to venture into leasing properties: congratulations. But what type of property should you lease? Which is the better option for your situation? This article aims to answer those questions by comparing residential leases with commercial leases in terms of profitability, hassle, long-term security, and the differences between each category’s tenants.
But before we delve into that, we need to answer one question: what is a lease?
According to the dictionary it’s: A legal document outlining the terms under which one party agrees to rent property from another party. Sounds simple, right? But it brings up the next logical question: how is a lease different from a rental agreement?
The difference really comes down to time. So where a rental agreement is a month-to-month agreement that can be changed at any time with just 30-days’ notice, a lease is a fixed contract for a specified amount of time that cannot be changed unless both landlord and lease-holder agree to it.
The fixed-nature of a lease is what makes it an attractive investment vehicle. And so this brings us to the focus of this article which is comparing residential leases with commercial leases.
As the names imply, a commercial lease is a fixed contract between landlord and lease-holder regarding a property being used for business or commercial purposes. A residential lease is the same, only it’s for a property being used for residential purposes.
So which is better? To determine this we’re going to compare the two types of leases using 5 criteria:
• Cost of the property
• Complexity of the property’s value
• Length of lease
• Legal responsibilities
• Management demands
#1 Cost of the property
As a rule, commercial properties tend to cost much more than residential properties. Exceptions to this rule may be found if the commercial properties are small offices or shop units. But when you’re looking at large multi-million properties such as shopping centres, large office blocks or industrial complexes, the cost of the commercial property is significantly higher than the residential property. As a result, commercial property investments tend to be made by groups of investors as a way of generating the money need to access the commercial property investment opportunity. If you’re not able to find other investors, or obtain sufficient funds through your broker, then a residential property may be more attractive to you.
#2 Complexity of the property’s value
Residential properties are extremely easy to evaluate, simply by looking at the price and market activity of other houses and flats in the area. However when it comes to commercial properties, these typically require access to highly specialised professional expertise in order to accurately determine the true worth of the property. For some, the hassle of doing this (on top of the huge costs involved) may be a big deterrent.
#3 Length of lease
Simply put, commercial leases tend to last around 5 years, whilst residential leases last about a year. Where the commercial lease has the advantage of longevity andlong-term guarantee of income, the residential lease tends to be more readily renewable. However, the residential lease tends to also have a higher degree of reduced occupancy due to the shorter lease period.
#4 Legal responsibilities
Something important to bear in mind is that the legislation surrounding landlord and tenant relationships differ between commercial and residential leases. Be sure to get comprehensive legal advice in order to understand your obligations in each situation.
#5 Management demands
Aka hassle! The responsibilities for repairs and maintenance are different between commercial and residential leases. So where commercial lease tenants are responsible for these costs, in a residential lease it is the landlord who bears this responsibility. And given that these costs can absorb more than 30% of the rental income, this can become a significant factor to consider (not mentioning the greater time costs involved for residential lease management).
One thing we haven’t discussed is the issue of income; an issue that will have a huge bearing when applying for a commercial mortgage.
Commercial lease properties tend to generate up to 50% greater rental income than residential lease properties. And so where the commercial lease landlord enjoys a greater consistent cash flow, the residential lease landlord has to regularly sell some of the properties to use the capital gains value of their properties to supplement their rental income.
So with all this information in hand, look through each category and write down whether the residential or commercial lease property emerges as a winner for you. And then book a chat with your business mortgage brokerwho will be able to help you explore your financial options for acquiring either type of lease property.