Property investment: Commercial or residential?
When talking property investment most people generally think residential real estate, often giving little or no thought to commercial property as a viable investment solution.
But a growing number of everyday Australians are recognising the potential of this sector and are cashing in.
In particular, a flood of mum and dad investors utilising self-managed superannuation funds are investing in small commercial properties, in what has become an extremely competitive market, but for good reason.
Commercial real estate, classified as property assets primarily used for business purposes, consists of three sectors – retail, office and industrial. Each with a range of asset classes, these sectors have their own cycle representing often very different risks and rewards.
Although some commercial properties offer investors yields akin to residential property, around 4%, others can achieve a return of up to 10%, after costs, depending on the asset class and risk rating.
The benefit of investing in commercial property is that it is characterised by longer leasing covenants than residential property – typically three, five or 10 years – with fixed or CPI annual increases and the added benefit of the tenant meeting the cost of all outgoings, including land tax if the tenant is publicly listed.
Furthermore, commercial tenants will generally take better care of a property, ensuring it is maintained and presentable.
But while also offering potential for high capital growth, the high return from commercial property investment is not without risks.
Historically, commercial property is far less predictable than residential property markets, with the potential for longer vacancy periods and poor resale for some specialised assets, influenced significantly by economic factors such as unemployment and consumer confidence.
Additionally, investment in the commercial market can sometimes be difficult due to stricter lending conditions, which may require buyers to have a minimum 30 to 50% deposit.
For the average investor diversifying into commercial property there are several important factors to consider.
Similar to investing in residential property, location is key. The type of commercial asset you purchase should be strategically located, paying particular attention to zoning restrictions that govern the sites potential highest and best use. Furthermore, consider the development potential of both the site and the building in instances where the current use ceases to be viable.
There are many commercial investment options, including mixed use dwellings, such as a retail shop with dwelling, which offers a double income stream, small industrial factories, strata-titled offices, retail strip shops, fast-food outlets and service stations.
While the risks associated with commercial property are higher than residential, the benefits can be significantly greater.