Commercial vs. Residential Property Investment – Pros and cons
Investing in a commercial property offers exciting opportunities, but as an investor you need to be aware that it can work quite differently from residential property investment.
‘Commercial property’ covers a range of options from office and retail space through to car parks and industrial properties like warehouses and factories. You may be surprised by this, but investing in commercial properties can be quite affordable, sometimes costing less than many residential properties.
Key differences between commercial property and residential property investment
The basics of investing in commercial property are very similar to residential property investment. You rent out your investment property and receive rental income from the tenant (or ‘lessee’ as commercial tenants are known). But there are some important differences that you should be aware of.
Long term leases
To begin with, commercial property leases usually run for much longer periods than residential properties – typically several years rather than 6 to 12 months. This gives you greater certainty of rental income, plus rents tend to be reviewed at least annually. However, when first finding a tenant or in between tenancies, investors can experience longer vacancy periods.
The impact of GST
Goods and services tax (GST) applies when you buy a commercial property, so allow an extra 10% on the property’s purchase price. As an investor, you can claim the GST back as an ‘input tax credit’ against GST charged on the property’s rent.
The lessee pays maintenance costs
Unlike residential property, the costs of maintenance, rates and repairs on a commercial property are paid by the lessee – not the landlord. This means more of the rent you receive goes towards your profit. However, be sure your commercial lease spells out who is responsible for the property’s ongoing expenses.
Some commercial properties can serve a limited purpose
It can be harder to secure a lessee on a property that is designed for a specific purpose. So opting for a property with multi-use appeal can help you attract a broader range of tenants.
Location is still key
As with any property investment, location plays a big role in the success of commercial property. However, when looking for commercial properties in particular, look for an area offering good transport links, a nearby pool of workers, and surrounding businesses that could offer support to lessees.
Could a commercial property investment deliver better rental returns?
Commercial property is usually regarded as a higher risk asset than residential property, and reflecting this, the rental return is usually higher. Plus the tenant pays most of the property expenses, giving the landlord a higher ‘net rent’.
However, the decision between investing in residential or commercial property is a personal choice that will depend on the investor’s financial circumstances, investment portfolio goals and willingness to take on this higher risk investment.
Funding your commercial property investment
There are a wide variety of commercial property loans available and most work in much the same way as a residential home loan. As an investor you can choose from a variable rate, fixed rate, combination between variable and fixed rate, principal and interest or interest-only loan, often with useful features available like fee-free additional repayments or an offset facility.
Alternatively, you may prefer a line of credit commercial mortgage. This gives you funding up to a predetermined limit and you only pay interest on the funds drawn down. Your Mortgage Choice broker can explain how each of these loan options work.
You usually need a larger deposit to secure approval for a commercial mortgage. Most lenders offer a maximum Loan to Valuation Ratio of 70%, which means you would need to save as a deposit a minimum 30% of the purchase price plus costs. If you are a home owner, offering your home as collateral (security) for the loan can be a way of securing a lower rate loan.
Your Mortgage Choice broker can help you select a commercial property loan suited to your needs and budget, giving you a clear idea of how much you can afford to borrow and the regular loan repayments.
The following information is provided for general education purposes only and does not constitute specialist advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific investment advice should be obtained from a suitably qualified professional before adopting any investment strategy.