Investing in residential properties vs commercial

Written by Douglas Ross in Buying on November 8, 2016

Investing in residential properties vs commercial

Commercial properties can be great investments. But they do come with their risks. The choice between investing in residential or commercial should eventually be a simple one and usually depends on your financial position and what you hope to get out of your investment.

Pros and Cons of Commercial Properties

Cost. This varies between the two. Commercial properties are often larger than residential. While they may be cheaper per square metre, their size may bump up the cost. You can find smaller retail and office spaces so this does vary. Low capital growth. As well as the risk of a higher cost for commercial properties, they also attract less capital growth. A commercial investment must factor in the interest costs for any loans taken to finance it. Deposits can be high due to strict tenancy agreements and economic changes. Why are the capital gains low? Commercial properties sit on less land than residential. The land appreciates rather than the building, which depreciates.
Higher rental yields. Commercial investments are a great way to increase cash-flow. With an average of 8-12% on yearly returns compared to residential averages of 3-4%, this is a big draw-card. However, residential investments do come with potential for capital growth. Risk of higher vacancy rates. It is rare for a residential property to go long without tenants. Commercial properties can run the risk of being vacant for months at a time.
Long leases. Residential rental leases often last between 1-2 years. Commercial leases factor in the need for tenants to build their business over time. This means agreements are often between 3, 5 and 10 years. Economic changes. The health of the economy poses a threat to your investment. Poor unemployment and a lack of consumer confidence can threaten the viability of any business occupying your property. Changes to the infrastructure in the surrounding area can threaten the value of your property. These changes can increase the number and severity of vacancies in your investment.
Heavenly tenants. Commercial tenants are invested tenants. Their business is their lifeline so they have a greater incentive to take care of your property. They also meet the costs of many outgoings that you would have to face as a residential investor. This includes: taxes and council rates, maintenance costs, utilities, cleaning and garbage disposal, and any marketing costs associated with the business. Resale challenges. Commercial properties that cater to niche business types risk being harder to sell.
Double income. Retail spaces that come with attached residences offer the chance to increase your rental income.

So, commercial properties can be great investments for those who want a higher rental income and are aware of the risks. In essence they are sort of like growth stocks as high risks come with higher rewards.

The decision is quite easy if you think about a few of the above factors. Firstly, can you put more into the deposit to offset interest costs on your loan? How long can you finance a vacant property? Will tax deductions and a higher rental income offset lower capital growth? Can you stick with your investment for longer?

Commercial property generally suits those with investment experience and more capital. It is generally seen as a step forward towards greater yields but also greater costs. If you do have the financial capability, approach it in the same way as any other investment. For example, is the property adaptable to a range of businesses? Additionally, does it have a strong location or is it at risk of becoming isolated by infrastructure changes? But you may not be prepared to take higher risks. You may also have less wiggle room with your money. In this case consider staying  in the residential market for now.