Residential and commercial property can be strong investment options and both play a vital role in the development of wealth over the long term.
Both asset classes can be valuable, however, they both do come with their risks.
When choosing between the two, it will depend on the investors' financial position, the overall strategy and the end goal of the investment.
Residential VS Commercial Property in Australia
In Australia, residential property has proven time and time again to be one of the most stable asset classes that typically offers solid capital growth returns.
Residential property also shows low volatility and an affordable entry point for the common investor looking to grow their portfolio.
Many Australians have chosen residential property when growing their wealth, and a natural progression when looking to diversify one’s portfolio can be the inclusion of a commercial property.
When looking into commercial property, a great starting point is to simply look at some of the pros and cons of the investment option.
Commercial Pros
Higher Rental Yields.
Residential properties across the capital cities typically average between 3-4%. Where commercial investments can average between 5-12% on yearly returns. Commercial property can be a potential drawcard when looking to increase the overall cash-flow of a portfolio [1].
Long Leases.
When it comes to residential property, rental leases typically average between 6 months to 1 year. Where commercial lease agreements often last between 3, 5 and even 10 years.
Commercial tenants twill generally aim to stay as long as possible to grow the business and they have typically invested capital into the premises. As a landlord, the aim is to secure long-term tenants such as companies and businesses that have a long track record of success.
Diversification.
Spreading opportunity and risk can be a vital part of building an investment portfolio. If an investor has already secured a property, whether that be residential or commercial, it could be a positive step to diversify and look to reap the benefits of the other asset class.
As the saying goes “don’t put all your eggs in one basket” leaving yourself overexposed to one type of property asset class. To read more about property diversification click here.
Commercial Cons
Upfront Capital Requirements.
The purchase price for a commercial property will vary depending on the location, size, and type (retail, office space, café, factory, etc).
A common and major factor that comes into play is the banks and financial lenders want a larger deposit upfront.
Banks typically associate commercial property with a higher risk profile and the LVR (Loan-to-value ratio), they are willing to offer is generally lower. It’s common for the bank to require between a 30% to 40% deposit from the investor, and they will lend the additional 60%-70% of the property’s value.
Saving a 30%-40% deposit can be a challenging task in itself, and keep a lot of investors out of the market altogether.
When borrowing for a residential property, it’s common to borrow up to 90% of the property’s value allowing for stronger leverage and helping investors enter the market sooner rather than later.
Longer Vacancy Rates Risks.
It’s not common for residential property to be empty for long periods. This is typically the case in capital cities dominated by homeowners and tightly held markets with consistently low vacancy rates. Generally, a good rule of thumb is to have a cash buffer of at least 4 weeks' rent to allow for a vacant period.
Commercial properties, however, can run the risk of being vacant for months at a time whilst waiting for the right tenants to take over.
Investors must be prepared to have a significant cash buffer in place to cover the potential loss of income and outgoings.
Economic Conditions.
The health of the economy and macro-economic conditions influences both commercial and residential properties.
When unemployment and lack of consumer confidence rises, a decrease in consumer spending generally follows and threatens the operations of any business occupying the commercial property.
During weak economic conditions, people still always need somewhere to live, and this has been demonstrated in past economic downturns where price falls have been less dramatic in the residential market. Residential properties have shown positive resilience and generally stabilsed and weathered the storm historically.
Resale Difficulties.
Commercial property tends to attract a niche tenant due to the fit-out and configuration of the property, making it harder to sell as the market is smaller. If the demand changes for that specific industry and weakens, it could also make it harder for the investor to sell or secure new tenants.
Key Takeaways
Commercial property can result in strong cash flow and can have a positive impact on the overall success of one’s portfolio.
As always, whether it’s a residential or commercial property, thorough due diligence should be conducted. All investors should understand the pros and cons of both asset options before entering the market.
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Jarryd Gauci – Property Investment Consultant
P: (02) 9939 3249
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