What type of property should I invest in?
When trying to find the right place for you to invest in, the residential vs commercial property debate no doubt comes to mind! If it doesn’t though, it is something worth considering as an option when looking into purchasing your next investment property. In this blog, we will delve into the pros and cons of investing in residential property vs commercial property to find which one works for you, along with input and expertise from Inovayt Senior Mortgage Broker Newcastle, Ben Robinson.
First, we’ll take a look at investing in residential property as it is probably the most common (and therefore probably the most straightforward!) to dissect. Residential property has many pros.
The property is readily available – residential property is generally more readily available than commercial, meaning that there is a larger supply and a higher frequency of properties traded.
It’s very easy to let/tenant – people are always looking for somewhere to live and will never not need a roof over their head!
Less challenging to gain entry too – residential property can be more accessible and less costly to gain entry to than commercial property. Costs and barriers to entry in the residential market are reduced, as most lenders help to absorb loan establishment costs, and ongoing fees tend to be more economical. Interest rates for residential property are also generally lower than that of commercial property.
The number of property types available – houses, townhouses, units, apartments, villas… the list is endless with the type of residential property that are out there for purchase! Different styles of residences have different capital growth and rental yield characteristics.
Banks can lend a larger percentage – some banks can lend up to 95 per cent which means that the deposit you need for a residential investment purchase is a lot smaller than what you will need for that of commercial property, but more on that later.
While residential property can see some very strong pros, some cons need to be factored in.
Property can be expensive to hold – and by hold, Ben explains this refers to covering interest costs on the property as well as insurances costs, maintenance costs and rates/body corporate.
Rental yield can be affected a lot by supply and demand – rental yield may not be as steady or consistent as it is with commercial property as it is affected quite heavily by supply and demand in the market, meaning that just because your property has gotten you $500 previously if the market supply increases making property more available, you may have to drop your price to compete with other places.
Another point that can fit into both the pro and con list is that prices can fluctuate with the market. A perfect example of this is how the Australian market has been over the past year during the pandemic. It was – and still is – a seller’s market as there are so many people who are wanting to buy property, but not enough property to suit the demand which is pushing prices up.
Now that we’ve covered off all things residential, we’ll take a look at the pros and cons of investing in commercial property. You may notice that there are a few similarities between the two of them, but we’ll go through them and take a look at the pros first.
The rental yield is generally higher – between these two properties, the rental yield for commercial property is usually higher than it is for residential property. Real Commercial says that while residential rental yields offer around 3 – 4 per cent, commercial rental yields often fall between 5 and 12 per cent, making them more likely to be cash flow positive investments. Depending on who has written up the lease agreement for you, commercial properties also usually feature a yearly increase which doesn’t factor into residential properties.
Tenants cover the cost of all outgoings – this point is probably one of the biggest pros when choosing to go with a commercial investment. Unlike in residential leases, commercial tenants cover all of the outgoing costs, including things like water, strata fees, rates, body corporates, etc. In a residential investment, all of these costs are covered by the property owner which makes commercial investing an appealing concept. In some arrangements, land tax can also be covered by the commercial property tenant.
There’s less volatility in the market – Ben says that “as commercial property is in its own market, there is a lot less volatility in the market.” Because it isn’t impacted by the residential property market, the commercial property market is a lot less likely to be affected by broader market factors.
Lease terms are longer – with residential property, lease terms and usually 6 or 12-months. For commercial properties, it is common to see lease terms between 1-5-years with the ability to extend built into the signed upfront agreements.
Many of these are huge pros but as with any investment, there are always a few cons as well that need to be taken into consideration.
Can be harder to let – style of property, size of the building, length of lease term, current use of premises, and strata restrictions (zoning restrictions) are all factors that can mean a commercial property can be harder to rent out. Ben also talks about the fact that because the space is generally for a specific purpose (eg. retail shop front, pub or restaurant, factory, etc), this makes it harder to let to as it targets a more niche business.
Can be harder to lend to – Ben says, “there are more establishment costs with lending, interest rates are higher, loan terms are generally shorter as well, and a lot of lenders will align the term of the loan to the term of the lease agreement (especially in rural or semi-rural locations).” This means that while residential loan periods are usually about 30 years based on tenancy, tenancy for commercial property is usually about 5 years which makes it a more difficult loan for lenders. It’s important to note that lenders have started to revise these lease-term restrictions, considering the inability to lend to commercial property purchases.
The period between tenants can be longer – as discussed in the first con, it may be difficult to find tenants for residential property. Because of this, when these tenants move out there may be a prolonged time in between tenants where you may need to cover costs.
Banks can only lend 70 – 80 per cent – while banks can lend up to 95 per cent for residential purchases, unfortunately, the same can’t apply for commercial property, with 80 per cent the maximum banks will lend you, meaning that you need to come up with (at least) a 20 per cent deposit making it a much harder market to break into.
Residential vs commercial property – who can you speak with to find out what’s best for you?
So, there you have it – some of the many points that can be argued for and against the residential vs commercial property investment debate! Each option boasts some pretty impressive-looking pros as well as sharing their side cons as well. It is important to note though that these points are just general advice, and don’t take into consideration your region and/or circumstances.
If you are looking at purchasing an investment property, it is best to chat with your mortgage broker about what options are available based on your personal situation and investment time horizon.