How does commercial and residential property investment differ?
If you’re looking for your first, or next, real estate investment and are tossing up between residential and commercial real estate, then no doubt you have quite a few questions.
Both sectors have their unique advantages and deciding between the two comes down to the personal circumstances of the investor and their investment aspirations.
Commercial real estate offers a broad range of property types, sizes and costs to suit a wide spectrum of investors. The over-arching sectors of industrial, office and retail have numerous sub-categories, with other opportunities existing in hotels, aged care, agribusiness and others.
Entry level investors are typically drawn to small strata office suites, small units within light industrial estates, or small-scale strip retail like fish and chip shops. Moving up the scale, high net worth investors and syndicates set their sights on freehold warehouses, low-set office buildings and neighbourhood shopping centres, while institutions target large scale logistics facilities, entire corporate office towers and regional and sub-regional shopping centres.
It’s fair to say there’s a variety of commercial property types to choose from and you can be assured that you’ll find a property that will suit your budget and investment needs.
So, what are the benefits of investing in commercial real estate?
While residential property can offer yields of up to about 4.5 per cent in some areas that have strong returns, commercial real estate tends to start at an average of 5 per cent and can offer yields of more than 10 per cent. This means you’ll experience a stronger return on your commercial real estate investment than a residential one. The right commercial property manager can advise you on the potential yield of your commercial property based on its size, demand and local area activity.
Longer lease terms
While apartments and houses are often tenanted on six to 12 month leases, commercial property requires tenants to lock into longer lease terms, typically of three years or more. This means you have the assurance of a ‘set and forget’ approach to your asset.
Longer leases generally have fixed annual increases
Another bonus of longer leases is that fixed annual increases are locked into the contract from the start. This is a different structure to residential investments where rental increases can’t be applied until the end of the tenant’s current lease. Spelling out the lease agreements at the start allows both the landlord and tenant to make long-term decisions with confidence.
Tenants pay outgoing expenses, repairs and make good at the end of the lease
Unlike residential property, the tenant of a commercial investment commonly covers outgoing expenses - such as utilities – and can often propose and pay for changes to the building’s shell for aesthetic and operational purposes.
So, what do I need to be mindful of?
Returns are determined on widespread issues
Whilst residential property yields are determined by supply and demand, commercial property is influenced by a greater number of economic, legislative and local / state planning requirements. Business confidence, infrastructure and consumer sentiment are major issues to reflect on when making a commercial investment, but also an opportunity for a savvy investor.
Properties can take longer to lease
Given the longer term of a commercial lease, tenants undertake significant due diligence before signing a lease because they want absolute confidence their operations will be suited to this retail, office or industrial facility for the long-term.
Commercial tenants can take longer to commit. Residential tenants can sometimes sign a lease on impulse as a stop gap measure – they may want to experience living in an area before buying – which reduces the time a home or apartment will be left vacant.
The right commercial property manager should have a comprehensive understanding of which businesses are looking for space and which are about to end their lease. By engaging the right commercial property manager, your vacant property will be promoted to the widest range or appropriate tenants, meaning you’ll find a new tenant faster.
There are higher upfront costs to purchase a commercial investment property
Investment property purchases, whether commercial or residential, require a larger deposit than that of an owner occupied property purchase.
With fewer incentives and generally a higher purchase price for commercial property, you need to ensure you have access to a significant deposit to kick start your commercial property investment.
If you are contemplating a commercial investment, the best thing you can do before diving in is to contact one of LJ Hooker Commercial’s property experts for all the advice and knowledge you need.