Should you invest in commercial or residential real estate?
When investing in property, most people typically consider residential options, e.g. a unit or house. However people are increasingly considering investing into commercial property as an alternative.
Commercial real estate is used either exclusively or primarily as a business premises. Commercial property has many similar attributes to residential:
- Property values tend to fluctuate, and turnover is typically low
- It pays a steady monthly rent while tenanted, and rents tend to increase as the economy grows
- You might be able to depreciate some of the items within the property
However, commercial property has some key attributes that are vastly different to residential property, including:
- Commercial property yields are often higher than residential yields in metropolitan areas
- Commercial property lease terms are typically three years or more
- Commercial property tenants are usually responsible for all maintenance of the premises
- The ability to find a tenant for commercial property is industry specific, i.e. if you have a retail shop, your ability to find a tenant is influenced by the strength of the retail industry
So if with commercial property you can get higher returns, longer leases, and the tenants are responsible for maintaining the property, shouldn’t everyone be looking at buying commercial property? Not necessarily as it does come with a unique set of risk factors.
Tenant turnover can be very slow in commercial properties, so you need to be prepared with sufficient cash reserves to weather the slower periods. If you’re borrowing to invest, could you handle 12 months of vacancy of your property? Furthermore, when you’re investing into residential property, it doesn’t matter if you rent it to a doctor, tradesman, teacher or student – as long as they pay the rent and look after the property. But with commercial property, your rental income is intrinsically linked to the fortunes of the businesses that will want to rent your property. If you own a retail shop, it’s highly unlikely that it’s going to appeal to a non-retail business.
Overall, a great commercial property could be an excellent investment. But its attributes are very different to residential property. In some cases, commercial property returns can outstrip that of residential property, however that can come with an equally higher level of risk. As with any investment, do your homework and make it’s the best option for your individual investment strategy.