When investors buy residential, they are essentially buying into the basic need for shelter.
Commercial property investors are investing in business activity. So why would you choose commercial over residential? After all, everyone needs somewhere to live.
Upsides of owning commercial property
Higher cash flow than residential
Commercial properties tend to carry more risk, which leads to a higher dollar value per square metre. Owners generally aren’t liable for day-to-day maintenance, which means better cash flow for your commercial investment
Lower tenant turnover
Commercial tenants take a lease on a property to run a business or provide services. As long as the commercial premises offers them what they need in terms of foot traffic or accessibility, they are more likely to occupy property for a greater number of years consecutively, increasing the return.
Most commercial leases are known as ‘net’ leases. This means the tenant is responsible for paying council rates, insurance and land tax. The tenant is also responsible for maintenance and repairs. This system differs from residential property where the property owner is responsible for outgoings. Tenants have long leases that include a provision to return the property to the owner in the same condition as when they took out their lease.
Annual rent increases
Most commercial leases have an annual rent increase built into the lease. The percentage is generally at least higher than CPI and tends to be above what you would expect for a residential rent increase.
Higher return on investment and yield
You should expect a rental yield of somewhere in the range of 5% to 12%, depending on the type of property. Commercial properties are nearly always cash flow positive.
Leases for commercial properties such as office, retail or industrial are longer. In some cases, as for retail in South Australia, the length and conditions of the lease are mandated by law. Tenants of commercial properties need certainty so they can conduct their business with confidence.
Risks of owning commercial property
Vacancy periods can be longer
Because requirements for commercial tenants are more specific, if your property becomes vacant, it could take months to acquire a new tenant. As a commercial investor, you need to have a buffer fund so you can manage outgoings while the property is not providing you with income.
Selling time is longer
Marketing is more specific for commercial property and buyers have certain criteria they need to meet. This can mean it takes longer to sell a commercial property, especially in an economic downturn.
Financing costs are higher
While not all commercial properties are hugely expensive, most tend to be priced higher than surrounding residential properties. However, if you can show your lender the property is a going concern with a good lease profile, most lenders are encouraged to lend.
Subject to business confidence
When business confidence is low, demand for commercial property drops. This could mean losing a tenant, or not attracting a solid tenant for the rent you need for your investment return.
Vulnerable to government contraction
Governments provide great tenants, especially growth areas like health and education. However, should a government change its activity in one of these areas, and you have a government tenant, it can be difficult to replace them.
How to choose: commercial or residential?
To make your choice, you need to understand your risk profile and capacity. If you need security over cash flow, then residential is a better option. If you’re chasing cash flow, then choose a commercial property that will offer you excellent returns over the long term.
Can we help with acquiring a Mount Gambier commercial property?
Call Herbert Commercial on 08 87 250 500 if you are looking to invest or sell commercial property or if you already own commercial property, ask us for a complimentary annual investment portfolio assessment. From this assessment, feedback may warrant the need to seek Herbert Commercial’s advice and expertise with formulating a plan to action restructuring or renegotiating the best lease scenario moving forward.
As the only dedicated commercial property agency in Mount Gambier, we have a network with and are sought after by national commercial agencies as a trusted extension to their services. Our wealth of commercial knowledge of the Mount Gambier market extends to the broader commercial market, meaning we can ensure you achieve your commercial property goals.