Comparison of Commercial vs Residential Fractional Investment

Real estate investing is fast evolving with fractional investment becoming a true game-changer in this segment. Following a recent amendment of SEBI, “Small and Medium REITS (SM REITS)” are supposed to offer a lucrative option for investors. Fractional investment in a plush property allows you to own a small portion of the same, but many people are still doubtful of where to invest- residential or commercial property. This article presents a detailed understanding of commercial vs residential fractional investment and the key differences between them. 

The Proposal of SEBI

The Proposal of SEBI in May 2023 holds special significance in the discussion of commercial vs. residential fractional investment. According to his proposal, there should be professionally managed and registered FOPs under the Framework for Micro, Small and Medium Real Estate Investment Trusts. There will be separate trustees, sponsors, and investment managers taking care of the transactions and property management. In a discussion paper, SEBI highlighted how the lack of standard, uniform selling practices affects property valuation and results in mis-selling. 

Fractional Investment vs. Traditional Real Estate Investment 

Traditional and fractional investments in the real estate sector offer contrasting avenues. Traditional investment demands a significant upfront sum, in exchange for which the investor gets full responsibilities as an owner. On the other hand, fractional investment allows small amounts as an entry point and allows investors to be the co-owner of an exclusive property. Being a fractional owner you get the ownership of the portion on which you have invested. Compared to owning an entire property, fractional investment offers lower returns but provides an exceptionally diversified investment portfolio. 

Also Read: How does Real Estate Fractional Investment Works

Commercial vs. Residential Fractional Investment: A Breakdown

Here’s a detailed look at the different aspects and key differentiators of commercial vs residential real estate investment by the Slice Vista experts. 

1. Type of the Property

• Commercial: Commercial property investment is one of the most lucrative ones amongst real estate investment. It includes premium office buildings, retail stores, hotels, and healthcare facilities, and more. Commercial properties as a fractional investment are essentially owned by businessmen, unlike individual retail investors.

• Residential: Residential fractional investments include plush apartments, condominiums, townhouses, and single-family homes, serviced apartments. These are primarily used as vacation homes.

Also Read: REIT vs Fractional Ownership of Property

2. Investment Objectives

• Commercial: Commercial properties mostly focus on income generation by leasing the property. It yields rental income.  The commercial properties are all set for a 13% to 16%  growth in the next five years.  Over the next few years, there will be high demand for business spaces because the post-COVID recession is coming to an end. To cope up with this growing demand, the commercial sector will attract institutional investors and foreign direct investment. It will further translate into a high potential for capital appreciation.

• Residential: Residential investment offers a more diversified plan. Investors can opt for income generation as well as capital appreciation. Sometimes, investors opt for a combination of both rental income and capital appreciation of the property. Plus, residential investment offers a hedge against inflation.

3. Income Potential

• Commercial: Commercial properties are meant for a generation. They have higher rental yields compared to the residential ones. Usually, commercial properties offer extended lease agreements with businesses, which translates into stable recurring income for years. Plus, commercial rentals are higher than residential ones.

• Residential: Residential properties offer a decent rental income but not as high as commercial properties. However, the location of the property influences the pricing structure to a large extent. Rental yields are higher in the high-demand areas. But, lease times are much shorter in the case of the residential property. It leads to frequent tenant turnover, affecting income flow. 

4. Management Complexity

• Commercial: Commercial property investment results in more complex operational management. Tenant management is extremely complex with things like lease agreements, maintenance, and other specialized requirements. However, there are property management firms that take care of the maintenance.

• Residential: Unlike commercial property investment, residential properties offer streamlined management procedures. It involves an easy and systematic process of tenant screening, addressing maintenance requests, and collecting rent. Hardly, you need to deal with stressful situations in the case of residential properties.

5. Market Sensitivity

• Commercial: Keep in mind that commercial property values and rental yields are subject to market fluctuations. While considering a better option between commercial vs residential real estate investment, you need to consider that during economic downturns commercial properties are exposed to higher risks due to decreased business activity. During COVID-19, when businesses across the world embraced remote settings, commercial real estate suffered a real setback, affecting investors significantly. 

• Residential: Residential properties offer comparatively better stability in the face of an economic downturn. While the need for housing remains always resilient, the rental rates and the capital appreciation of residential properties also experience fluctuations during economic downtimes.

6. Investment Minimums

• Commercial: The entry point of commercial properties is significantly higher than residential ownership, even as a fractional entity. Commercial buildings that are available for fractional shares are usually Grade-A properties which are priced over crores. It means investors need larger capital reserves even for a fractional share/ownership.

• Residential: Unlike Commercial properties, the residential fractional model needs lower entry amounts. As a result, these are more accessible to first-time property investors with smaller budgets. But, at the same time, it allows them to foray into the real estate market.

7. Liquidity

• Commercial: Commercial property investment offers lower liquidity than residential ones. Precisely, these are difficult to sell, considering the longer lease times. Plus, for fractional shares, you need a “go-ahead” from the co-owners when it comes to selling your shares. Now, if you need cash quickly, it will be challenging to sell commercial shares. Also, commercial properties have a limited vase of potential buyers in the fractional model.

• Residential: On the other hand, residential properties often have higher liquidity even in the fractional setup. There are potential investors interested in residential real estate properties like vacation homes and similar others. No doubt, for an urgent need for liquidity, residential properties are ideal.  

Also Read: How to Start Fractional Investment in Real Estate India

Final Words: The Experts’ Take 

Commercial properties are always a “stable” and ever-growing asset class that delivers at least 4X to 5X rental returns, compared to residential properties. Returns from a commercial property range between 12-18% based on the location of the property. Also, the combined IRR (internal rate of returns, commonly called annual growth) of a commercial property is at least 13 to 15% for a period of four to five years. Residential properties do not have such a high potential for income generation. 

So, if you are weighing the pros and cons of commercial vs residential fractional investment, it depends on the investment objectives. Fractional investment in both segments- commercial and residential is ideal for long-term plans. It should be goal-based and for a minimum period of five years, if you want to see the real returns on your investment. Both residential and commercial property investment delivers good returns when done with a realistic strategy. Consider your income levels, saving mobilization, risk appetite, investment pattern, and goals, before leaping in the real estate market. 

Also Read: Benefits and Risks of Fractional Ownership in Real Estate