Commercial vs residential property investment: Which is better?

When it comes to property investing, most Australians set their sights on residential real estate but investing in commercial property is another way many are building their wealth via brick and mortar.

Of course, investing in commercial or residential property both come with risks and AMP chief economist and head of investment strategy Shane Oliver says the biggest argument in favour of commercial property investment vs residential was a higher income flow.

“Like all property, it depends on where you go, for example, you get exposure to a bigger range of the economy by going into commercial,” he explains.

Commercial investment has the benefit of exposure to a bigger range of the economy. Picture: Getty

“In other words, you get exposure to industrial, office, retail and mixed, whereas in housing you are just exposed to the housing market.

“There’s a potential for more diversification in terms of economic exposure in the commercial property market than there is in the residential property market.”

Interest rates and loan differences

Melbourne-based Mortgage Choice broker Joshua Almond says when purchasing a commercial property, the deposit required significantly differed from a residential buy.

“As a general rule of thumb, you’re probably looking at a 20% contribution when it comes to a residential property purchase,” he said.

Melbourne-based Mortgage Choice broker Joshua Almond says investors must consider the differences in deposit requirements. Picture: supplied

“From a commercial perspective, it could be anywhere between, say 25% to say 35%, plus stamp duty costs.”

One other big difference between commercial and residenital loans was the interest rates.

“I think a lot of people are probably unaware that you’re going to probably pay a high rate of interest for (commercial) … which is aligned to what the banks deem as a high rate of risk,” Mr Almond says.

“Their thinking is in the unlikely event of default, and they’ve got to move the property on or sell it, it will likely take longer to sell that property, which is in some ways, deemed more specialised compared to, say, a residential property based in Perth.”

Loans for commercial investments are significantly shorter than regular residential home loans. Picture: Getty

Loan terms for a commercial loan were anywhere from 10-15 years, compared to 30 years for a residential loan, he added.

“The one thing that banks have done pretty well in the last 10 years is that they’ve started to try and align some of these mismatch items –  i.e. loan terms and interest rates –  closer towards what a residential loan looks like,” he said.

“Some banks take on commercial lending and loans over a longer period of time, so between 20 and 30 years.”

The impact of the wider economy

Mr Oliver says commercial property growth tended to be more in line with inflation, and was more likely to suffer from bouts of oversupply.

“It is arguably more sensitive to the state of the economy than residential is,” he adds.“You can get a bit more volatility in commercial property than you might get in residential.”

There was the argument that residential investment was probably easier for most investors to understand, he says.

Tax advantages

Both investment types have similar tax advantages, Mr Oliver explains.

“You can negative gear both, because the nature of the tax system allows for negative gearing. Both have access to the capital gains tax discount so there’s no real taxation differences at a high level, although you may find some, when you drill down into it.

“But in terms of the big picture around capital gains and negative gearing, they’re both fairly similar.”

Custom approach

Mr Almond says the biggest thing he let prospective clients know when it came to commercial borrowing, was there is “no one size fits all.”

“The large discrepancy between interest rate and loan term and contributions, all those three things can be dependent on if you’re buying for your own purposes, to occupy, or if it’s for investment.

“And it can also vary depending on the type of asset you buy as well.

“So an industrial warehouse, or it could be an office, or it could be a retail shop, all three will dictate, or banks will dictate how much you need to contribute, what the interest rate may look like and what the loan term looks like.”

Industrial warehouses are a popular option for commercial property investors. Picture: Getty

It was these factors that make it vital to speak to a broker, Mr Almond adds.

“Even from an investor perspective, serviceability is probably considered and looked at in a lot more detail on what it would be from a residential home loan perspective as well,” he said.

“Mum and Dad investors that come in, or first time commercial property purchasers come in and think it’s a similar process, it’s not.

“We take a lot of that challenging stress away. We’ll go and understand what a client can and can’t do and help.”

This article first appeared on Mortgage Choice and has been republished with permission.