Is commercial property a better investment than residential?

By Greg Bell

If you are ready to become a property investor for the first time, it’s time to decide commercial or residential? The type of property you choose to invest in can affect your finances for the next few decades, so choose wisely.

Residential property investing

Residential properties might at first seem like a safer choice for investment, as economic shocks may be less likely to impact the residential market. Residential real estate may also be easier to procure, and require less documentation during the loan application process.

Finally, investing in residential property can mean a lessened requirement for financial reserves. Residential property overall is considered a lower risk investment than commercial property, and may be more attractive to a first time investor or one who doesn’t have deep pockets.

However, commercial properties have many advantages over residential ones. If you can manage the added complications, you could receive a much higher return on investment by choosing to invest in a commercial property.

Commercial property investing

Commercial properties can offer significantly greater returns than residential properties; up to four times higher in some cases. Commercial leases are much more negotiable than residential leases, and the contract for a prime location can be drafted in your favour. You can also invest relatively small sums of money in small commercial spaces as opposed to a house or townhome.

Tenants in commercial properties are more likely to be long term, meaning better financial security and a positive cash flow. During occupancy, the tenant is responsible for most outgoings as well, and annual rental increases are expected and can be contractually enforced. Tenants who lease commercial property also may take better care of it, as they are generally conducting business out of the space.

Determining the value of your investment property

Residential property valuation is typically arrived at by comparing housing prices to rents. Commercial property valuation is more complex as the value of the property is significantly affected by tenancy. If the property is occupied by a tenant with a long term contract, it can be valued much higher than an untenanted property.

Since many residential rental contracts are drafted for a time period of just six to 12 months, turnover is typically much faster than in a commercial building, where leases may run in multiples of years with the option to extend far beyond the original lease period. It is harder to replace a commercial tenant, but tenants may also be less likely to leave.

Financing investment properties

Financing a residential property can be easier than financing a commercial one, but certain differences may arise for residential purchases completed with the intent to use as a rental rather than a primary residence. However, buying residential property as an investment is still typically easier than buying commercial property for leasing purposes.

Tenancy will affect a range of factors in the financial institution’s proffered loan. A property that comes with a tenant must be thoroughly vetted and contracts examined to ensure the terms are favorable to you as the future landlord.

Depending on the final valuation of the commercial property, you may need to apply for a business loan, provide additional documentation, and provide a larger down payment. If the property is untenanted, you’ll also need to have financial security that allows you to pay outgoings until a tenant is secured.

Bottom line: if you have the wherewithal to support a commercial property through any potential season of vacancy, the pros beat the cons. Commercial property may well be a better investment than residential property, especially if properly managed. If you are interested in commercial property management, contact the team at Ray White Surfers Paradise today.

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