Residential vs Commercial: Which Is The Right Property Investment For You?

Most real estate investors only ever consider putting their money into residential property – and there are good reasons for that.

But commercial property can be an effective investment for some landlords, especially those looking to generate income from their assets.

With that in mind, we look at the pros and cons of investing in both commercial and residential property, to help you discover which suits your investment goals.

Key differences between commercial and residential property

The most obvious difference between residential property and commercial property is the way in which it’s used. Residential real estate is leased to tenants who use the property as their home. Commercial real estate is leased to a business, which then uses it to conduct its business.

Just as there are different types of residential property, there are also different types of commercial property.

  • Retail. These range from shops on the main street and in shopping centres to petrol stations, restaurant spaces, cafes and more.
  • Office. This can include small suburban and regional offices through to large office blocks in the CBD.
  • Industrial. Warehouses, factories and depots all fall into this category of commercial property.

Even within these categories of commercial property, there can be real differences in the characteristics of different assets. For instance, the returns for a retail space in the CBD is likely to be driven by different factors from a small shop in a suburban mall.

Benefits of investing in commercial property

There are several reasons some property investors choose commercial property over residential property

  • Higher-income. Commercial property usually comes with a higher yield than residential property. For instance, the median office yield in the Perth CBD is currently 6.5%, while the median gross yield for residential property is 4.3%, according to CoreLogic. This can be beneficial for investors looking to positively gear their investment property or live off the income from their asset.
  • Longer leases. Most commercial leases contain fixed annual rental increases, often based on the consumer price index (CPI). The lease terms are often also longer – usually between three and five years. This means your income is locked in and the tenant must usually pay out the lease if they leave. For this reason, your cashflow tends to be more guaranteed.
  • Lower maintenance costs. In a commercial property, most day-to-day maintenance issues are the tenant’s issue rather than the landlord’s. A commercial tenant is also usually responsible for paying insurance, as well as council and water rates.
  • Different influences. The commercial market often runs independently of the residential market as property values tend to be more closely tied to yield.
  • Greater diversification. For investors who already own residential properties, commercial property can help them diversify their property portfolio.

Disadvantages of investing in commercial property

Despite these benefits there are also real downsides to investing in commercial property compared with residential property, including:

  • Longer vacancies. Even though commercial leases tend to run longer, tenants can be harder to find. This can lead to longer vacancy periods, in which you make no money at all. This can negate any increased income you receive.
  • Potentially greater risk. Although a commercial property can sometimes provide greater income, this also often comes with greater risk. This can include the risk that an economic shock will force a business renting your space to close. There is also the chance that a site could ‘fall out of fashion’ leading to a decrease in demand – for instance, if you own a retail space and a new shopping centre is built. In short, there are a lot more factors at play.
  • Lower capital gains. Because the value of commercial property is often closely tied to yield, it’s less likely to experience the kind of strong growth the residential market can experience. While this can help you in a downturn, it can mean you miss out on real capital growth, which is one of the main benefits of property investing.
  • Less scope to borrow. Lenders are often less inclined to let investors borrow for commercial property without a significant deposit – often more than 30%.

What’s the commercial property market like in Perth?

Right now the Perth commercial property market is going through a period of transition. The COVID-19 pandemic has changed the way people behave, and many once safe commercial assets – such as CBD retail and office space – are becoming less utilised. For this reason, we expect that a lot of central Perth properties will convert from commercial to residential over the coming years.

However, there are still real opportunities in the commercial property market, especially in suburban areas. This includes suburban shopping centres, as well as industrial space.

Should you invest in commercial property?

You should always let your investment goals dictate the type of investment property you buy. If you’re interested in generating income or you want to diversify your portfolio, you could consider investing in commercial property, especially if you already own residential property.

That said, if you’re looking to generate income from your asset, you could always choose to invest in high yielding residential property. For instance, according to REIWA data, some Perth suburbs offer residential property yields well above the city average, including Stratton (7.2%), Brookdale (6.8%), Koondoola (6.6%) and Armadale (6.5%). What’s more, these properties don’t have the same inherent economic risks that commercial real estate carries.

Before deciding whether to invest in residential or commercial property, you should always consult your financial or tax adviser.

Want more?

If you’d like to know how our award-winning team can help you make the most of your investment property, contact our friendly team today.

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