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How residential and commercial property investment really differ (when the economy takes a dive)

May 19, 2020
Categories: Commercial, COVID-19

If the coronavirus has exposed anything to property investors, it’s the real difference between residential and commercial property investment.

Commercial property versus residential property. It’s been a long battle. There are lovers and haters of both investment types and no shortage of information proving one is better than the other.

But how do residential and commercial property investment compete on unfamiliar territory? COVID-19 is a new battleground… What’s the real difference between residential and commercial property when the economy takes a dive?

How residential property and commercial property investment differ during economic uncertainty

Less panic for commercial property investors

The real difference we’re seeing between residential and commercial property is that commercial property owners tend to hold on to their assets in uncertain times.

There are less fire sales; there are less panicked divestment decisions; there is less brashness in the commercial property market.

Commercial landlords ride the bumps and figure ways of getting back on smooth terrain, without dumping their asset. How? Commercial landlords have ammunition.

Big league property owners use reserve funds, which is money set aside for unexpected costs, they’ll negotiate deals with tenants if their business is struggling, or they’ll survive from other investments in a diversified portfolio. Commercial property owners prepare for the worst.

But residential property owners, especially the Mums and Dads of the investing world, don’t always have the luxury to wear the brunt of a financial crisis.

Residential property investment versus commercial property investment.

Homeowners usually make mortgage repayments with salary from their day job or business and from rental income. Sadly, that leaves them with little option if their employer or business is in jeopardy from economic uncertainty, but to sell the property.

Commercial property is less leveraged

Not only are commercial landlords better prepared for bumps in the market, their properties are less leveraged than residential properties.

Property loans may not be 80 per cent of the property value, as with residential property. They are probably closer to 50 per cent or even 30 per cent.

A less leveraged property lets commercial property owners absorb more shocks in uncertain times, before they’re forced to sell their asset and repay the bank.

What does this mean for both residential property and commercial property markets?

If owners of commercial property can take bigger punches than residential property owners, you’re going to see a lot less commercial assets thrown on the market for a quick sale.

Asset values are derived from the willing sale and willing purchase of an asset on the market. So, as we’ve seen from the stock market’s volatility, with share values plummeting overnight, more sales means more value changes.

Which makes the opposite true: Without a buyer and a seller, there is simply no move in value.

If you have less owners putting for sale signs in front of their property, you’ll have less evidence to suggest a change a valuation. That’s a property fundamental, and is what keeps commercial property owners a little calmer when the financial world around them crumbles.

For the same reason, this is why I think we’ll see a fair bit of hurt on the residential landscape.

residential versus commercial property

Many households are less able to maintain rent or manage their mortgage as a result of their income taking a hit. Some will need to sell, and sell fast. Meaning quick movements in the residential property market.

A slower moving beast

Commercial property is a sophisticated investment.

The reason commercial property is not as popular an investment as shares or houses is because there’s more to investing than seeing, liking and buying.

There are due diligence periods, settlement processes, complex finance terms, long lease agreements, and so many more opportunities for headaches that new investors just turn to investment companies or unlisted property trusts.

Sophistication is what makes commercial property a slower moving beast. And a slow moving beast is also far slower to be affected by the dangers in the market.

You won’t see the overnight blips as in the share market or the race to sell as in the residential property market. So, in theory, any change to property values in the slow moving commercial property market will be long but shallow.

As commercial property landlords stepping on to a new battleground in 2020, that’s very comforting.

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