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Is investing in residential or commercial property better?

February 25, 2020
Categories: Commercial, Investments

Both residential property and commercial property can come with great benefits for investors. But investors will need to look at a range of factors when deciding which investment is better. Let’s see if there’s a clear winner between them.

Residential and commercial property both have great benefits, particularly for those who know how to invest in them. For example, residential property is a familiar investment to most Australians while commercial property investment can be known for large returns.

But when deciding whether it’s better to invest in residential or commercial property, it’s important to consider a few factors that separate both property types:

  1. Quality of tenant
  2. Length of lease
  3. Return on Investment
  4. Property outgoings
  5. Accessibility
  6. Risk
  7. Simplicity
  8. Simplicity (part two)

Let’s dive into each and see which out of residential and commercial property is the investment winner.

1. Quality of tenant

A commercial property tenant has a big impact on a property value. If a tenant has desirable traits, such as being a large national brand with decades of historical performance, it is likely to have a positive outcome on the property value.

That’s because there’s less risk of such a robust tenant missing rental payments, going into liquidation or closing their doors.

Commercial property landlords can increase the value of their investment by placing a high-quality tenant in their premises, and this is a huge advantage for investing in commercial real estate.

Large Format Retail Property

Meanwhile, residential property tenants do not impact the property value. There is no opportunity for landlords to directly improve the property value by having a better tenant in their house.

2. Length of lease

We’ve already seen how the quality of the tenant impacts a commercial property‘s value. So, you’d be correct to assume that the longer the lease, the better the commercial property value.

This means commercial landlords can add value to their property by extending the lease agreements they have with tenants. Residential property landlords don’t have that luxury.

The length of lease in a residential property doesn’t impact the property value. Nor are residential property leases longer than typical commercial property leases.

Residential property leases usually run for one or two years, while commercial property lease terms can be up to five, seven, ten, or even 15 years. This means that if you’re buying a commercial property, you can expect far longer income security from your investment.

3. Return on Investment

It depends on the property size and location, tenant quality and length of lease, but commercial property investors typically receive much higher returns and yields (earnings generated from the investment).

A residential property is known for receiving annual yields between 1 per cent and 3 per cent. Meanwhile, commercial property is likely to provide you with much greater yields of 7 per cent to 10 per cent.

4. Property outgoings and expenses

Expenses and outgoings are usually much higher in commercial property than residential property. More can go wrong and replacement parts (such as air conditioners) can be far more expensive.

Like residential property, land tax, water rates and body corporate can chew further into a commercial landlord’s pocket. Unless their tenant has signed a net lease.

Net leases mean the tenants pay the outgoings for you. This is a huge advantage of commercial property over residential property, which will see the owner fork out for all outgoings and expenses.

5. Accessibility

Buying a residential property as an individual is very achievable for most Australians. In fact, 65 per cent of Australians own their own home according to the 2016 Census.

Residential property investment versus commercial property investment.

With banks requiring a minimum 20 per cent deposit on most residential properties (and only 5 per cent deposit in certain cases), an individual investor could own their own home for as little as $40,000 for a $250,000 property (with stamp duty considered).

Commercial properties are much more difficult to purchase individually. At least for an asset of substantial value.

Big league commercial properties will cost millions of dollars. And for commercial property financing, the bank is usually only willing to accept a 40 per cent deposit on these properties.

This is why many turn to commercial property syndicates to partake in commercial property.

6. Risk

Commercial property investments can sometimes carry more risk than residential property investments.

This is because commercial property is more susceptible to market conditions than residential property. People need homes to live, so there is always underlying demand for homes. Meanwhile, tenant demand for commercial property is driven by business activity, which in turn can be driven by the economy.

Understanding those risks is key to good investment in commercial property. Investors should be aware that every investment comes with risk and should discuss any investment opportunity with their accountant or financial adviser.

7. Simplicity

Residential property is known for being a simpler investment. There is far more available information on how to invest, and it’s typically a familiar investment to most Australians: You’ve either invested in it yourself or know someone who has.

Commercial property has a lot more factors to consider: Commercial financing, due diligence, lease and purchase negotiations, and many more.

A solid network of property professionals is also crucial for knowing how to invest in quality commercial real estate.

8. Simplicity (part two)

A popular alternative to taking on the burden of investing alone in commercial real estate, is investing alongside a commercial property syndicate.

A syndicator will handle all the dirty work for you, ensuring the best possible chance of success in commercial property investment, while aiming for the least amount of risk.

Whether the simplicity of residential property, or high returns and long-term cash flow of commercial property, there’s much to consider before investing in either residential or commercial property. You should assess your own appetite for risk, understanding of either investment, and your own investment goals.

And as always, speak to your accountant before proceeding with any investment.

To find out whether commercial property is a good investment for you, get in touch with Properties & Pathways today.

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