The first thing people think of when property investment is mentioned is residential property. It’s something most people understand to a degree and are familiar with. It’s accepted as a safe and practical way to invest, especially when property owners typically own the home they live in, so they have walked the buying path before.
The thought of a different type of property owner probably didn’t arise. Often people assume that big companies own their buildings. It might surprise people to learn that big-name banks, supermarkets like Coles and Woolworths, petrol stations and stores like Target and Myer lease on long term contracts rather than own their real estate.
Knowing that, would you be interested in buying commercial property instead of residential property for your investment? There are certainly wins and risks involved no matter which way you swing. It’s worthwhile weighing up the pros and cons and seeing which option works in your favour.
For a rundown on the three main commercial property types, retail, office, and factory, see our previous article.
Wins for commercial property investment
The commercial property market is full of opportunities. While big-box retail units and high-rise offices can sell for tens of millions, there are cheaper options available with a wide range of price points.
Compared to residential investment properties, commercial properties typically:
• Offer greater returns
• Have significantly longer leases
• Provide rental yields between 5% and 12% (compared to residential yields of 3-4%)
• Are better cared for than residential and have less wear and tear
• Include fixed annual rent increases around 3-4%
• Come as a net lease, meaning tenants are responsible for paying council rates, insurance, land tax, maintenance, and repairs
• Are given frequent upgrades to fittings to keep it modern and attractive, paid by the tenant
Risks for commercial property investment
Because they are so dependent on retail, commercial properties are vulnerable to economic changes. They also typically have a slower rate of capital growth compared to residential properties, so the rental income levels are important.
Should there be a dip in the economy, it may be that your commercial investment will stand vacant for some time. Not only does that mean no income from that property, you will also need to cover overheads like security, power, cleaning, and insurance, especially if the building is part of a larger shopping complex where standards come pre-set.
Long leases do help keep your valuable tenant, however, if they do choose to leave after the lease attracting another tenant can be very difficult, unlike residential leases where a new tenant is usually waiting to come in before the other leaves.
• You may have to spend a lot of money on refitting a building to make it attractive to a new tenant or you may have to reduce the rent to convince a tenant to come in. There are even cases where retail tenants have been able to get free rent for one year to sweeten the deal
• You are not able to claim tax rebates on as many items because the tenant is paying for (and claiming on their tax) many of the running costs. A big attraction to owning a residential property is the tax breaks from maintenance, depreciation and running costs
• Building a commercial property and any repair work is expensive and involves more red tape than building a residential building or making modifications and extensions
• Slower rates of capital growth
• Commercial investments are considered high lending risk. Banks require a deposit of 30 per cent, or even 40 per cent before they will approve a loan
• Commercial loans typically come with higher administrative fees and interest rates
• You won’t be applying for a home loan, you will be applying for a business loan and will need to provide a business plan and profit forecasts
Commercial investors generally need to conduct significantly more research before buying a property than someone buying residential.
With residential properties, the lease terms and conditions are set and pretty much identical, making them not only clear cut and straightforward but also quick and inexpensive to draw up and action.
When it comes to commercial investments, every lease is complex and different. Every item is open for negotiation. Combing through an existing commercial lease is painstaking and will require help from a licensed professional who understands commercial property law. You will need to understand every part of a lease to know what you are buying into.
Should I invest in commercial property?
There are great gains to be made, but also risks involved with commercial property investment. Before you proceed, check that you have considerable financial standing to cover costs and make alterations out of your own pocket during vacancies.
Typically commercial investors already have a large residential property portfolio. For new investors, residential property investment is a safer bet and easier to get into, but for those who are serious about making a professional investment, with funding available to get through tough times, the risks may well be worth it.
Because every circumstance is unique it’s essential that you seek advice from a professional team before making any purchasing decision.