Commercial vs Residential Property Investments in the UK for the next 5 years (2024 to 2029)

When looking for property investment opportunities in the UK, it can be hard to decide whether to go for residential or commercial properties. Both have their pros and cons, and the right choice can depend on your financial situation and investment goals. Join me, Liam J Ryan, as I guide you through the ins and outs of commercial and residential property investment and help you make the right decision.

What is Residential Property?

Residential property refers to properties that people live in, such as houses, flats, cottages, townhouses, and more. This type of property is popular with new property investors.

What is Commercial Property?

Commercial property refers to properties used for business purposes. This could be shops and other retail spaces, warehouses, factories, restaurants, hotels, hospitals and other types of commercial space. This type of property is owned by more established property investors or investment businesses.

Is it Better to Invest in Commercial or Residential Property in the UK?

Each has its own benefits and drawbacks. Residential property investment benefits from a lower cost of entry, wide availability of funding options, and a high demand for housing in the UK. However, profit margins can be lower and there is more potential tenant turnover. Commercial property demands a larger initial investment but offers a more stable investment with longer lease times and the chance to take a more passive, hands-off approach to property management.

Potential Returns on Your Investment

Investors usually profit more from commercial property investment rather than residential property investment. But the world of commercial property management is not for everyone, and when losses are made, they can be more significant. Another thing to consider is the resale potential of either kind of investment property.

Commercial Property

Benefits:

Reliable, stable source of income. Commercial rental contracts are longer than residential at 5 years or more, basically guaranteeing income for that period.
High rental yields. Commercial properties earn more in rent per square foot than residential properties.
Less ‘hands-on’ than residential – most commercial leases are FRI leases, meaning Full Repairing and Insuring – this means the tenant is responsible for building maintenance and insurance.
Tax benefits – the sale of commercial property is not subject to Capital Gains Tax, business tax rates can be lower than residential rates, and investors can claim tax relief on certain costs associated with owning and managing commercial property.

Drawbacks:

Higher initial costs. Commercial buildings usually cost more than residential property and you will usually need to provide a higher deposit when using a mortgage as funding. Mortgage interest rates are usually higher for commercial properties too.
Renovation costs can be very high, especially for larger units that need expensive additions like fire escapes, ventilation systems and dry risers.
Lack of liquidity. Commercial properties can be harder to sell than residential and can sit on the market for months or even years before a suitable buyer takes an interest.
Increased complexity. Complex documentation and contracts mean more paperwork for you, and the need for solicitors to handle legal matters drives up expenses.

Residential Property

Benefits:

Easier to invest with less capital required. Residential properties are often cheaper than commercial ones and you can usually obtain a mortgage with a lower interest rate. Lenders ask for a lower deposit percentage too.
High demand for housing. With house prices rising every year, more and more people are looking to rent a home. Unless there are significant problems with the property or you are charging well over the average for rent, it won’t be hard to find potential tenants.
The housing market in the UK has shown long-term growth over the last few decades and shows no sign of slowing down, making residential property a solid investment that is likely to appreciate over time.
Faster return on your investment. Except in cases where a house needs extensive repairs and renovations, you can expect to start earning income from your residential property fairly quickly.

Drawbacks:

More ongoing costs are involved. From repairs and maintenance to insurance and PAT testing, you will have to foot the bill.
Residential properties offer a lower ROI than commercial buildings. They offer a lower rental yield per square foot and limited cash flow options.
Potential tenant issues. You may have to deal with late or missing rent payments, damage to your property, or legal disputes.
You will need to be on hand to deal with any issues as they arise, meaning you may need to be available 24/7 unless you use a property management company, which will cut into your profits.

Factors That Influence ROI

Investing in residential and commercial properties in Britain currently offers different returns, with the average yield for residential properties at 4.1% and commercial properties at 6.5%. Various factors can influence these returns, impacting the overall ROI for investors.

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Location

The most popular residential properties have good nearby amenities such as shops, schools, and hospitals. Access to public transport and road connections are desirable too. Properties in good locations with low crime rates and near local employment hubs can increase rental yield and property values.

Likewise, commercial properties have specific needs depending on the type of business in residence. Shops and other retail spaces need to be in locations that offer high footfall, whereas properties used for warehousing and logistics need to have good national and international transport links. Commercial properties in the right location for the industry can command higher rental yields.

Market Conditions

Housing market trends can influence property values and rental yields, as can economic conditions such as employment rates, inflation and wage growth. In commercial property investment, factors such as consumer spending patterns, business growth rates and economic cycles can affect demand for commercial spaces.

Interest Rates

Changes in interest rates can affect mortgage costs, influencing the affordability and attractiveness of property investments. Lower interest rates generally reduce borrowing costs, potentially increasing the ROI of both commercial and residential properties.

Market Trends and Forecasts

Here are some current trends and predictions that can affect the ROI of both residential and commercial properties:

Inflation Rate

The UK inflation rate has been on a downward trend since reaching a peak of 11.1% in October 2022. With global energy prices easing, it is widely predicted that the inflation rate will hit the Bank of England’s target of 2% by early 2025. Lower inflation can benefit both residential and commercial property investments by reducing the cost of goods and services, stabilising rental income, and potentially increasing property values. However, it also means that rental prices may not increase as rapidly, potentially affecting the rental yield.

Rising Property Prices

The announcement of a general election in July 2024 means that predictions are more difficult to make but if the incumbent Conservative government is replaced by Labour, this could lead to more aggressive wealth taxes. Labour has also promised to build 1.5 million homes that could potentially stem the rise in property prices, although it remains to be seen if this will come to fruition. Some experts speculate that house prices will drop slightly by the end of 2024 but this trend is not expected to roll onto 2025 – they go on to suggest that residential property price inflation will reach 18% by 2029. The Office for Budget Responsibility (OBR) boldly predicts that average house prices will rise to an average of over £300,000 by 2029, although any growth will largely depend on other factors including employment rate and wages.

Some experts see 2024 as a positive turning point for the commercial property market in the UK, and commercial property lending is forecasted to rise by 32% by 2028. This is based on surveys of property investors which found that 23% believe there is growing demand for the commercial sector, and some have even reported taking advantage of current lower purchase prices on commercial property.

Rising Property Prices

The COVID-19 pandemic has drastically altered work patterns, with millions of people shifting to remote work. This change has reduced the demand for office spaces and other commercial properties. While the market is slowly recovering, the lasting preference for remote work means that many employers are reducing their expenditure on large workspaces. This shift has resulted in lower occupancy rates and rental incomes for commercial properties.

Technological Developments

Technological advancements are continually reshaping the commercial property sector. To stay competitive, industrial spaces may require extensive remodelling and upgrades. These renovations can be costly and time-consuming, affecting the short-term ROI. However, well-modernised properties can attract higher-quality tenants and command higher rents, potentially increasing long-term returns. While eCommerce has resulted in less footfall for brick-and-mortar shops, the demand for warehousing and logistics has increased as businesses pivot towards market demands.

Choosing the Right Investment For You

Choosing between residential and commercial property investments can be tricky, and I suggest considering your investment goals, options available for funding, your previous experience and your financial situation. Residential properties can offer a steady income and have lower barriers to entry, which makes them ideal for new investors or those looking for long-term stability. Commercial properties offer higher potential ROI but do need a larger initial investment and expertise, making them a better choice for more experienced investors who are in a financial position to take bigger risks. Be sure to take all of these things into account to make an informed decision that aligns with your investment goals.

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