What's the Difference Between Retail Properties and Residential Properties? Merits and Risks to Consider for Real Estate Investment

When considering real estate investment, people sometimes ask, "Which is better, commercial or residential properties?"

A residence

Both are income-generating properties, but they differ in nature, such as financing, reasons for eviction, repair costs, and vacancy periods.

To get straight to the point, there's no single right answer that works for everyone. However, I personally prefer retail properties. Today, I'll explain why.

The strengths of a residence are the ease of understanding demand and the ease of obtaining financing.

Housing is a necessity regardless of the economy.

The big advantage of residences is that rental demand is relatively easy to predict.

As long as people are living, they need a place to live. By checking factors such as distance from the station, surrounding facilities, floor plan, age of the building, amenities, and rent, you can get a general idea of the resident's image.

You can determine the compatibility between a region and apartment layout, such as a studio apartment for areas with many single residents or a 2LDK or larger for areas with many families. Another advantage is that there are many rental examples, making it easy to research the appropriate rent.

The value of a retail space varies depending on whether it is better suited for a restaurant, a hair salon, or an office—even if it’s in the same location. In that regard, retail properties offer many points of comparison, making them an investment where it’s easy to quantify market rent levels and vacancy risk.

Easily evaluated by financial institutions

Compared to retail stores, cash registers tend to be eligible for loans from financial institutions more easily.

From the perspective of financial institutions, residential rental properties are considered easier to forecast demand for, and it is generally easier to find new tenants after a tenant moves out. Another reason is that there are many comparable sales, making it easier to assess collateral value and projected income.

Condominiums and apartment buildings that are well-located, relatively new, and have high occupancy rates are properties that are easy to present to financial institutions. If you can secure long-term financing, you can keep your monthly payments low and maintain a positive cash flow.

For those who want to expand their property portfolio using financing, Regi is an accessible option.

Residences tend to incur costs with each move-in and move-out.

Move out even if not dissatisfied with the property

While the demand for retail spaces is stable, a characteristic is that it's difficult for owners to control the reasons for tenants vacating.

People move out due to life changes such as employment, transfers, marriage, divorce, childbirth, further education, or purchasing a home, even if they are not dissatisfied with the room or its management. No matter how good a room you offer, you cannot stop life's changes for the tenant.

Restoration and equipment replacement pile up.

When a tenant moves out, it is necessary to clean the unit, replace the wallpaper, repair the flooring, and inspect the fixtures and equipment. If the air conditioner, water heater, bidet toilet seat, kitchen, or other equipment malfunctions, the landlord is generally responsible for addressing the issue.

Even if the amount for each repair isn’t large, repair costs can add up as the number of units increases. Since the need to replace equipment increases as the building ages, if you purchase a property based solely on the surface yield, your net income may end up being less than expected.

The fact that tenant turnover and repairs to interior fixtures occur on an ongoing basis is what sets this apart from retail stores.

The appeal of retail properties lies in the fact that tenants can customize the space themselves.

The tenant often bears the cost of interior finishing and business equipment.

One of the reasons I prefer retail properties is that it's relatively easy to keep the owner's repair burden down.

In stores, tenants create the interior design to suit their own business. It is common for the tenant to provide the necessary equipment for their business, such as kitchens and seating areas for restaurants, shampoo stations and mirrors for hair salons, and shelves and lighting for retail stores.

This approach differs from the typical residential rental model, where the owner furnishes the unit with air conditioning, a kitchen, a sink, wallpaper, flooring, and other amenities before renting it out.

Of course, the owner may be responsible for the building’s structural components, roof, exterior walls, common areas, and main plumbing lines. Since the allocation of repair costs varies depending on the terms of the lease, this does not mean that “retail tenants will not incur any repair costs at all.”

However, in properties where the tenant bears the cost of interior finishing and business equipment for the exclusive use area, minor repairs tend to occur less frequently compared to residential properties. This is one of the attractions of investing in commercial spaces.

Stores that are generating sales won't relocate easily.

Another appeal of the store is that as long as business is going well, there's little reason to leave.

For a store, location is more than just a physical space. It's where brand awareness is built, repeat customers are acquired, and sales accumulate.

Relocating involves significant costs and effort, including interior renovation costs, moving expenses, sign replacement, various notifications, and the period during which business operations are suspended. There is also a risk of losing existing customers.

For that reason, stores that are generating solid sales in that location aren’t likely to leave anytime soon. Unlike convenience stores, they don’t close down simply because of marriage or a job transfer.

If you can secure long-term, stable tenants, you can minimize leasing costs and vacancy periods while generating a steady stream of rental income.

What happens when a retail property becomes vacant?

You can use the notice period before vacating to find the next tenant.

The store may take longer to find the next tenant compared to the register.

However, it is not uncommon for retail lease agreements to include a provision requiring the tenant to give notice of termination at least three or six months prior to vacating the premises.

Although the contract period varies, a benefit for the store is that it can secure a certain preparation period from notification of vacating to the tenant's actual move-out.

In the case of retail spaces, notice of vacating is often set at one month in advance, and in some cases, the property owner will wait until restoration work is completed after the tenant moves out before actively beginning the leasing process.

On the other hand, if a store receives a three-month notice of vacating the premises, the landlord can begin reaching out to potential new tenants and conducting recruitment activities even while the current tenant is still in operation.

If we start recruiting early and can proceed with viewings and negotiations, there's a possibility we can hand over the property to the next tenant immediately after the current tenant vacates.

While there's a risk of vacancies in retail spaces becoming prolonged, there's also room to shorten the vacancy period by effectively utilizing the contractual notice period for moving out.

This point is a surprisingly big advantage when operating a retail property.

It can sometimes take a while to find the next tenant.

On the other hand, just because there is a notice period for vacating, it doesn't necessarily mean that a new tenant will be found before the move-out date.

The types of businesses that can occupy a store are limited by factors such as location, size, frontage, ceiling height, electrical capacity, water supply and drainage, exhaust equipment, and parking.

Even if the previous tenant was a restaurant, it's not always guaranteed that the next restaurant will move in right away. The remaining interior may not have value if it doesn't fit the next business type.

Therefore, when purchasing, you must consider what kind of business could move in next if the current tenant vacates, whether the rent can be adjusted to secure a new tenant, and whether it can be repurposed for other uses such as offices or warehouses.

Instead of only starting to act after receiving notice of vacancy, if you build relationships with surrounding tenant demand and real estate agencies on a daily basis, you can effectively utilize periods of three or six months.

It's important for store operations to be able to act immediately when you receive notice of a tenant vacating, rather than waiting until the space is vacant to think about it.

Look not only at the building, but also at the tenants' businesses

When investing in a property, it's necessary to consider not only the building itself but also the businesses of the tenants.

It's not reassuring just because the rent is covered; we consider whether the rent is reasonable for sales, if there are increasing competitors, and if the industry has a future.

At first glance, even if the yield is high, if the tenant's business is unstable and the property remains vacant for a long period after they move out, the actual profitability will significantly decrease.

Conversely, if a business has been operating for many years, has a loyal customer base in the area, and the rent is at a reasonable level, it is attractive. Because stores are highly individual, if you assess them correctly, they can also be an investment with little competition.

Which is better: the store or the cash register?

The advantages of a residence are that rental demand is easy to read and financing from financial institutions is easy to obtain. The sales market is also relatively large, and it tends to be easy to find buyers when selling in the future.

On the other hand, the advantage of a commercial property is that if the tenant invests in interior finishing and equipment and the business is doing well, they are more likely to stay for the long term. Some properties require fewer minor interior repairs during tenancy, making them less labor-intensive to manage.

However, the register is prone to frequent move-ins and move-outs and repairs, and once a store becomes vacant, it can take time to find the next tenant.

In other words, while retail spaces are easy to fill when vacancies arise, they also experience frequent tenant turnover; in contrast, while store locations tend to retain tenants for long periods once they move in, it is much more difficult to fill them once they become vacant.

It is dangerous to judge solely by the dividend yield without understanding this nature.

I still like retail properties.

I personally prefer properties suitable for retail stores.

Because if good tenants move in and the business does well in that location, there are long-term benefits for both the owner and the tenant.

Tenants invest their own money to build their shops and gain recognition within the community. Owners provide the building and receive rental income as long as the business continues. I think it's closer to supporting a business in that location rather than simply renting out a room.

Of course, we must carefully evaluate properties that have a poor location, excessively high rent, limited uses, or tenants with unstable business operations.

Nonetheless, retail properties with good balance between location and rent, and with tenants who have been operating for a long time, have their own unique appeal, different from office buildings.

If ease of financing and resale is a priority, a retail property is excellent. On the other hand, if you want to assess the tenant's business viability and location and aim for long-term occupancy, a commercial property is also a strong option.

Which to choose depends on your experience, funds, financing situation, and holding policy.

And if I'm asked which I prefer, I prefer the store.

It's precisely because it's not easy that your ability to assess properties and tenants will show in the results. I'm drawn to retail properties precisely because of that depth.