WHICH IS BETTER COMMERCIAL OR RESIDENTIAL PROPERTIES?
Residential properties are underpinned in their values by owner occupiers. Their values do not fluctuate as much as other investments because people need to live somewhere and do not move as often or as easily, so therefore there is a natural “brake” in the wild ups and down swings of other investments such as shares.
So whether people own their own homes or are tenants in another landlords properties they need the dwelling to live in and it’s a “must have” versus a “nice to have”.
Generally demand is greater than supply due to many reasons one of which is an increasing population either through immigration or natural birth. We have experienced a doubling of value every 7 to 12 years on average, which is around a 5% to 7% pa annum capital growth on long term average.
This is not a guarantee that this will continue to happen in the future.
However the up and down cycle is created firstly by demand which pushes prices up which attracts developers to build more supply until they reach saturation and prices no longer go up and in some instances goes down slightly.
It than takes several years until excess supply is fully consumed and demand is once more greater than supply and pushes prices up and the whole cycle repeats itself.
Generally the rental yields are around 3% to 5% gross, for residential properties.
When supply matches demand the yield sits generally at around 5%. As prices are driven upwards due to demand, yields drop down until it reaches around 2% to 3% gross where it property values generally peaks.
At some stage of the cycle it maybe cheaper for a tenant to buy their own home versus renting and this adds to the ups and downs of a residential cycle.
Commercial Properties work on completely different dynamics and apart from owner occupiers, are driven by investors looking for the best returns.
Rental yields can range from 5% to 12% gross. Generally those in the country will get a higher yield.
Their values are underpinned by their rentals.
For example if the commercial rates of return are currently at say 7% gross and if one was achieving a rent of $50,000pa than the value of the property is $714,285 ($50,000 divided by 7%) if rents went up to $60,000 than the value also goes up $857,142 ($60,000 divided by 7%). However if accepted yields dropped to 5% than on a rent of $50,000 it’s now worth $1 million ($50,000 divided by 5%) and not $714,285 simply because the accepted yield is now 5% and not 7%.
So on rental of $60,000 it’s worth $1,200,000 ($60,000 divided by 5%) and not $857,142.
As you can see its a lot more clinical and less emotional.
Also most commercial tenants sign a long term lease (example 5×5 or even 10×10) and pay all outgoings and in some cases even land tax.
However whilst the yields are higher than residential properties their capital growth can be much lower.
It can also take a long time to find a commercial tenant if it’s vacant.
Businesses normally rent commercial properties and there are much higher risks associated with businesses being successful.
ADVANTAGES VERSUS DISADVANTAGES.
Residential properties are a lot safer than commercial properties as an investment and whilst their yields are generally lower, their capital growth is generally higher than commercial properties.
The vacancy rates with finding tenants for residential properties are much lower (around 2%) and much higher with commercial properties (8%).
Commercial properties generally show a lower capital growth (0 to 5%pa) and is underpinned by the properties ability to increase its rental.
Disclaimer: This article contains general information; before you make any financial or investment decision you should seek professional advice to take into account your individual objectives, financial situation and individual needs. Click for more detail regarding this disclaimer.
As commercial properties are riskier as an investment it should not be considered if you are unable to fund the interest on the loan in the event that it becomes vacant as it could remain vacant for many months and even years.
However if you have a large portfolio of residential properties and you can tolerate a potential long vacancy in a commercial property than the yields from a commercial property can assist the funding of a low yielding (generally negative) residential property portfolio.
If you are new to property investing you should stick to residential properties.
Commercial properties cover shops, factories, offices, warehouses etc.
They all have different dynamics and all have varying risk profiles.