The difference between commercial and residential property investments

Before you embark into commercial property investment you must recognise that there are considerable differences between commercial and industrial properties compared with residential real estate.

The main ones can be summarised as follows:

Commercial properties tend to yield a higher return than residential properties – usually between 5% to 10% net; compared to residential properties which yield 3% to 4% gross (then you still have to pay the rates, taxes, insurance, etc.) That’s because professional investors require a higher rental return from their commercial properties to make up for the relatively weaker capital growth, the longer vacancy factors and potentially higher risks. 

Leases for commercial properties tend to be for longer periods, often 3 to 5 years as opposed to the 12 month lease which is common in residential properties.

Rents are usually charged as a rate per square meter and rent reviews are incorporated in the lease document. Rent reviews may be calculated every year or 18 months and can be an increase to market rental or an increase by the increase in the amount of the CPI. Some leases have a clause preventing the rent to drop even if the prevailing market rent drops.

Tenants in commercial properties usually pay all the outgoings such as rates, taxes and insurance, while with residential property the landlord pays these.

Because your tenant conducts their business from your commercial property, they tend to look after it better than residential tenants do, usually maintaining and painting the property.

Commercial properties are less management intensive – tenants don’t tend to bother you for small items like leaking taps.

Lenders will usually only lend up to 70% of the value of commercial or industrial properties. I don’t know of any mortgage insurers who will lend on commercial property. This means the investor needs to come up with more equity to purchase a commercial property. Residential Vs Commercial

The initial capital required to get in to a good commercial property is usually considerably higher than that required for residential properties, as a good shop or office in a strong centre may cost 2 or 3 times the price of a unit or apartment. Sure you can buy cheap shops in secondary centres, but they will usually have secondary tenants who are more likely to go broke and leave you with a vacancy.

Interest rates for a loan on commercial properties are usually higher than for residential properties.

When vacancies occur in commercial properties, they are often vacant for considerably longer periods than the week or 2 you may have a residential property vacant. How often have you seen a shop in your community shopping centre vacant for weeks or months?

The cycle for commercial properties is different to that for residential properties and is even more dependant on the general economic factors than the residential market.

The lease required on a commercial property is much more complex and usually requires a solicitor to prepare it.

It’s easier for you to pick a top performing residential investment. Most beginning investors know what to look for in a residential property – they have lived in a house, but few would know what a tenant looks for in a good commercial or industrial property unless they have conducted their own business from one.