Investing in Residential vs Commercial Properties

You’ve decided to invest in property, but should you invest in residential or commercial? As with everything there are pros and cons for each, and according to the experts it all comes down to risk and return, and what you’re aiming to achieve with your investment. Let’s compare the two markets and see where the differences lie.

Investing in residential

When people consider investing in property, it’s usually residential that they’re thinking about. And while that’s a great option for investment, there are always going to be advantages and disadvantages.

Benefits

  • The main benefit, and one that’s often a make or break for a lot of people, is that you need a smaller deposit. By and large, residential investments are much cheaper than commercial ones, and the deposit is obviously in direct proportion to the final sale price. This is especially important if the investment is your first.
  • Depending on your income and credit history, you may also be able to potentially borrow 100% of the purchase price, eliminating the need for a deposit altogether.
  • Lenders are often much more lenient when it comes to borrowing criteria for residential property.
  • The residential property market tends to be much more predictable than the commercial market. Historically when it comes to residential, properties tend to double in value within 7-10 years. This is not the case with commercial. One reason for the unpredictability is there are different kinds of commercial properties to consider – commercial, industrial, and retail.
  • Residential properties tend to let out quicker. While the leases are shorter, they are easier to find a tenant for. This means there will be less time that the property is vacant.

Investing in commercial

People in favour of investing in commercial property claim the strategy is safe because it has a much higher cash flow potential. But what are the other benefits and are there any disadvantages?

Benefits

  • According to CoreLogic RP Data, the average rental return for residential properties is 3.6 per cent across Australia’s capital cities. Compare this to commercial property where it’s common to get between 8 and 12%  rental yield and you can automatically see the benefit in the higher rental return.
  • In commercial investment, companies tend to sign a much longer lease than residents looking at new homes. Residential turnover is generally 6 to 12 months, however, with commercial properties, the leases can be anywhere between 3 and 10 years. Customising the space is generally in the hands of the tenant, so they tend to stay longer if they can.
  • For commercial properties, the landlord doesn’t pay a lot of the rates. In most cases, the tenant covers rates and insurance. Add this to the higher rent that tenants of shops and offices pay, and your cashflow gets a nice boost.
  • While the lease term tends to be longer, rent is still reviewed annually. It is usually increased by the CPI or 4%, whichever is greater.
  • In commercial properties, tenants also tend to take better care of the premises. The look and condition of the property is important to their business integrity and impacts a lot more people, such as staff.

Disadvantages

  • Commercial properties tend to be more sensitive to economic conditions. Business flourishes when the economy is strong. This means demand for commercial property tends to rise with the strength of the dollar. However, while things can be rosy during the good times, when there is a downturn, the demand generally falls.
  • While the lease term is generally longer than residential leases, it can be much harder to find a tenant for a commercial property. Commercial properties commonly have long vacancies, meaning you’ll have to cover all costs during this period. For residential, properties may be empty for a week or two between tenants; for commercial properties, this could be months or even years.
  • If your commercial property is in a booming industrial or commercial area, the changes in supply may cause a threat to your tenancies. As businesses grow, their spaces need to as well, and if new and improved spaces are opening nearby, there’s potential for your tenant to move on rather than renew.
  • Buying commercial property is generally much more risky than buying residential property. Commercial property is much more expensive and complex, so if something goes wrong, there’s a lot more money at stake.
  • If the property needs any renovation or repair, it can eat a big hole in your pocket. Fixing up a commercial property involves so much more than getting a new carpet and a fresh slap of paint. It could mean new air conditioning, a complete refit, upgrade of facilities, or even the removal of asbestos. While you may need to renovate a residential property, the figures are always going to be much higher when dealing with a large commercial space.

So what should you do? As with any investment, choosing residential or commercial largely depends on what your end game is and what fits with your current portfolio. There’s not right or wrong answer and it will never be black and white. It’s all about your circumstances, so do your research and seek advice when needed.