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Investment property – commercial or residential

Investment Property – Commercial or Residential

With many new investors entering the property market over the last year, competition for suitable residential investment properties has become fierce. As an alternative, some investors are starting to recognise commercial property as a viable investment option.

For most of us, a residential property investment is fairly straightforward and easy to understand, whereas commercial real estate is unfamiliar territory. Here’s a quick look at some of the things you may need to consider when investing in a commercial property in Australia.

res-vs-comm What is commercial real estate?

Commercial real estate is classified as property assets that are primarily used for business purposes. This property falls into three main categories: office, retail and industrial. 

Within these categories, size is often a determining factor in terms of the type of investor they attract. Small office space and retail shops are often just as popular as residential property investments. Larger offices and retail spaces, together with industrial property investments, are usually favoured by those with more commercial property investment/management experience.

As with most investment property, the capital growth potential of commercial property depends on its size, location and rental demand. In this respect, commercial and residential property investments are very similar.

The major difference between investing in commercial property compared to residential property is the rental agreement. With commercial property, the property is usually leased to a business under a detailed contract for a much longer period – typically three, five or ten years. 

Commercial property has some unexpected benefits

A commercial property lease includes fixed agreements for CPI annual rent increases, and offers the added benefit of the tenant being responsible for meeting the cost of all outgoings. This means that the tenant has to pay for just about everything, including rates, maintenance and even land tax in some states (where the tenant is a publicly listed company).

And when it comes to maintenance, you can usually expect your commercial tenant to do a much better job of looking after the place than a residential tenant. That’s because it’s important to their business that the premises look tidy, attractive and well maintained. This aspect of commercial property investment can save you a considerable amount of money and hassle compared to a residential investment, so it’s an important consideration.

Commercial property often generates higher rents than residential property of approximately the same price. Whilst smaller office and retail space usually returns about the same as residential property – around 4% – larger commercial properties and industrial properties often return as much as 10%.

What are the drawbacks?

One expense with commercial property that you won’t encounter with residential property is in the preparation of the leasing contract. This should be drawn up by a legal professional who is experienced in the commercial leasing area as it is a lot more complicated than an ordinary residential lease.

Additionally, commercial property is usually more influenced by the economy than residential property. Demand for your property will be determined by factors such as consumer confidence, unemployment, economic growth, interest rates and so on. Whereas demand for residential property is fairly constant.

These factors can often make it harder to find a tenant for your commercial property. You may find that you need to look harder and longer to find a tenant and you may have to make renovations or change of use applications with council to suit any tenant that you do find. This can prove to be time consuming and expensive (even though the changes may often be tax deductible, you could still find yourself out of pocket).

Additionally, lenders often apply stricter conditions to financing commercial property than they do with a residential property investment. For example, it is quite likely that you will require a 30% deposit to purchase a commercial property and for some specific properties, you may even require as much as 50%.

Location is key when considering a commercial property. You need to consider how your tenant will use the building and ensure it is strategically located to capture the right customers. For example, if you are purchasing a retail space you will need to consider foot traffic and parking. Additionally, there are often zoning restrictions that govern a building’s use and these need to be checked out thoroughly before you make your purchase.

Find out if the numbers stack up for you

With any property investment – whether it is a residential or commercial property – doing your research is the key to making a profit. Research your commercial property carefully and talk to us about your financing arrangements before you make the decision to buy. 

We can help you to determine if the numbers stack up for your choice of commercial property, work out if it will be in line with your investment strategy and goals, then help you find the most suitable financing for your objectives. It pays to talk to professionals about your plans well ahead of time, so if you’re looking at making a commercial property investment in 2015, just drop us a line.

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