Comparing commercial and residential property investment
If you are looking for a sound real estate investment, look beyond the typical two bedroom apartment and consider expanding your portfolio with a commercial property. There are three types of commercial property – office, retail and industrial.
There are some significant differences between investing in commercial and residential real estate, each with a potential positive or negative impact on your investment.
Commercial property is also much more expensive to buy than residential property, and the risk is also considered higher because if its vulnerability to market conditions. Banks will require a larger minimum deposit, usually around 30%, and the interest rates will be higher than a residential property. While the average rental return for residential properties in Australian capital cities is 3.6%, a commercial gross rental property will be somewhere between 8% and 12%. However, the value of a commercial property can drop sharply once the property becomes vacant or the lease is due to expire. The property is extremely vulnerable to economic conditions and any changes in infrastructure, so your promising investment can lose value abruptly if external conditions change without warning. In contrast, residential property prices is relatively low risk with a low return.
Length of lease
Commercial property leases are usually set for an initial five year period, which is much longer than a residential lease of six or twelve months. Industrial property can have a lease up to ten years long. However, this is counterbalanced by the relative difficulty of finding new tenants for a commercial property – while you might have your tenant for longer, it can take a long time to replace them.
A commercial lease document is generally about 50 or 60 pages in length, far more complex and involved than a residential lease, which is usually only four pages long. The commercial lease is never a standard document so you need to read it carefully and ensure you understand all your responsibilities.
Most commercial leases are net leases, making the tenant responsible for costs that would otherwise be paid by the owner, such as insurance, maintenance and utilities.
While you are responsible for maintaining a residential property and paying rates and insurance, the property owner is usually not liable for the equivalent costs of a commercial property. This is fortunate because maintenance of a commercial property can be particularly expensive as the building must always meet the latest safety requirements.
A commercial property can be a valuable addition to your property portfolio so long as you are prepared for the potential risks. The longer leases and higher returns can balance out the relatively safe and slow return from residential property.