With residential property prices escalating at an unprecedented rate, many investors looking to enter the property market are finding it increasingly difficult to get a foot on the first rung of the property ladder.
As an alternative option, more and more investors are investigating the merits of commercial property to help them grow their wealth. But what are the major differences between commercial and residential property investments? What do investors need to look out for?
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CAPITAL GROWTH POTENTIAL
Capital growth potential is an important consideration for investors, and this is one of the key differences between residential and commercial property. It is generally believed that the capital growth potential of commercial property is not as reliable as with residential property. This is because demand for residential property is growing all the time as the population grows, usually at a higher rate than the supply of new homes.
Generally speaking, demand for commercial property tends to be less and it is usually reliant on economic growth, rather than population growth. When the economy is in a growth phase, more new businesses start up and this increases demand for commercial premises and supports capital growth, but this generally occurs at a much slower rate than with residential property. Additionally, commercial property is more vulnerable during an economic downturn than residential property.
Whilst residential property may win on capital growth potential, commercial property may often be the stronger contender when it comes to rental yields.
For example, rental yields from residential property are generally around 3 – 5% per annum, which is much lower than with commercial property, which can often return as much as 5 – 12% per annum depending on your choice of investment.
An additional benefit of commercial property is that rental increases can often be written into the lease and may even be tied to economic factors. This makes it much easier to plan / anticipate the rental returns you will receive on your investment.
TENANT AVAILABILITY AND SECURITY
Whilst rental yields may be higher for commercial property than with residential property, finding tenants may not be as easy. Commercial properties can often sit vacant for months or even years, particularly when the reason for the vacancy is an economic downturn or a long-term tenant has gone out of business. Finding new tenants may often require remodelling or refitting the premises, which can also pose an additional expense.
However, once you have found a good tenant for your commercial property, they do tend to stay longer and are less likely to default on the rent payments than residential tenants. Residential leases can be as short as three months, where commercial property leases tend to be at least 3 – 5 years or even longer.
Commercial property investment entry price points may be extremely attractive to the smaller investor, however there are some disadvantages when it comes to putting down a deposit. Lenders are often much more reluctant to approve loans for commercial property investments and usually require a deposit of at least 30%. For a residential property investment, you can often get loan approval with a deposit as low as 5%.
MAINTENANCE AND OTHER PROPERTY EXPENSES
This is another area where commercial property investment can often win over residential property investment. With a residential property, the investor is responsible for all maintenance costs and expenses such as repairs and operating expenses like the council rates.
With a commercial property investment, the tenant is usually responsible for all expenses including general maintenance, repairs and operating expenses such as rates.
A BALANCED INVESTMENT PORTFOLIO IS BEST
When it comes to deciding whether you should invest in residential or commercial property, we recommend that you look at each investment opportunity on its individual merits and do extensive research to determine both its capital growth and rental yield potential.
A balanced portfolio would most likely include a combination of both residential and commercial properties that have been specifically chosen to meet your personal investment criteria. A balanced approach will also assist in mitigating any risks associated with your investment over time.
If you’re considering a residential or commercial property investment, then don’t hesitate to give us a call. We’ll help you crunch the numbers to determine if the property you are considering will help you meet your investment objectives. We can also help you to get pre-approval on your loan so you can easily determine which properties meet your buying criteria.
FINANCE FOCUS | JULY 2016
The information provided in this page is general in nature and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information with regard to your objectives, financial situation and needs. You should seek independent advice from your financial adviser before making any decisions.
AUSTRALIAN MORTGAGE AND FINANCIAL ADVISERS (AMAFA)
Phone: 07 3378 2056
Fax: 07 3378 2069