Commercial Investment Property: Is it Worth It?
When you’ve decided to invest in property, you face an important choice. Do you buy a residential or commercial property? Here’s what you need to know before going down the commercial route.
You already know the answer to “why is property a great investment?” Now, you have a key choice to make. Do you buy a residential or commercial investment property?
Each offers its own pros and cons. This article focuses on how to succeed with a commercial investment property.
What is a Commercial Investment Property?
These types of properties cover the gamut of professional and businesses services. Your property could be as small as a shop or as large as a factory space.
The key is that it’s a property that a business enterprise can rent from you. This means it must offer the facilities that businesses need.
The Pros of Commercial Property Investment
There are several key advantages that investing in commercial property offers. Many of these also don’t carry over into residential property investment. These include the following.
Pro #1 – Higher Investment Returns
CoreLogic examined the yields of both residential and commercial properties. They checked across each of Australia’s capital cities.
They discovered that residential properties generate an average yield of 3.6%. By contrast, commercial properties tend to generate between 8% and 12%. This means you earn more when renting out a commercial property.
Pro #2 – You Command Longer Leases
Residential properties tend to come with shorter leases than commercial properties. Usually, you’ll secure a residential tenant for between six months and a year. This may then move onto a rolling contract, or you re-sign the tenancy agreement for a similar period. Most residential tenants don’t want to tie themselves down to your property for longer than this.
A commercial investment property allows you to ask for much longer leases. Usually, these leases can range in length from three years up to 10. This is because commercial tenants tend to work towards long-term business plans. They need an established location to work from. Furthermore, any investment they make in the property also incentivises them. They’ll keep the lease going for a longer period of time.
Pro #3 – Fewer Ongoing Rate Expenses
Residential properties come with monthly costs. You’ll often pay most of the rates attached to a residential property. This includes water, council rates, and any relevant body corporate fees.
This isn’t a problem with a commercial investment property. Commercial tenants tend to handle these rates themselves. They’ll also cover any insurance attached to the building. This lowers your monthly fees, often by hundreds of dollars.
Pro #4 – Tenants May Add Value
It’s unlikely that a residential tenant will do anything to add value to your property. Remember that they’re often there for the short term. This means they have no incentive to make improvements. They often won’t redecorate or change carpets.
Commercial tenants take a different approach. They often need to install new furniture and items to run their businesses. They may also need to adjust the property’s space or structure. These improvements raise the value of your commercial property. Plus, you may be able to charge higher rents to later tenants.
Pro #5 – Lower Property Prices
You’ll usually find that a commercial property costs less than a residential property.Even those larger in size tend to command lower prices. This means that you don’t have to spend as long raising your deposit.
These lower prices also mean that you can establish yourself as an investor in less time. When the commercial property starts to generate returns, you can then put this money towards other investments. Moreover, commercial properties don’t fluctuate in value as much as residential properties. This means you don’t have to worry about market spikes affecting your investment.
The Cons of Commercial Property Investment
Unfortunately, every investment carries some downsides. The same is true of a commercial property investment. Here are some of the disadvantages to consider before making your decision.
Con #1 – Economic Sensitivity
The stronger the economy, the more demand there is for your commercial property.
The problem arises when the economy struggles. A struggling economy leads to companies going out of business. Fewer companies means that demand drops, which may force you to lower your rents.
You may have to deal with economic challenges on both the national and local levels.
Con #2 – Longer Untenanted Periods
Though residential properties attract shorter tenancy periods, they also attract more tenants. If the property goes vacant, it’s not usually difficult to find a new tenant.
Unfortunately, that’s not always the case with a commercial investment property. You’ll often only attract tenants from a limited number of sectors. This becomes more of a problem with a specialised property.If the property goes vacant, it may stay that way for months at a time. In the worst case scenario, you might spend years searching for new tenants.
Con #3 – New Properties Present More of a Threat
Increased supply creates a challenge for both residential and commercial investors. But it’s more of a problem for the latter.
When more commercial properties become available, your potential tenants have more choice. If your property doesn’t offer exactly what they need, you lose out.
Moreover, you also have to think about the growth of your current commercial tenants. Their business may become so successful that they outgrow your property. This means they have to leave to find somewhere new, leaving you to deal with a vacancy.
Con #4 – The Cost of Renovations
Not every tenant carries out the renovation work needed for their business. Furthermore, you may have to renovate to attract new tenants.
Either way, that’s money out of your pockets. Moreover, you’ll generally spend more on commercial property improvements. Sometimes, they cost many thousands more dollars than residential ones.
For example, you may have to undertake a large-scale asbestos removal. Or, you have to alter the structure and floor layout to suit the needs of prospective tenants.
The Differences Between Residential and Commercial Investment
You can’t approach a commercial investment as though it’s a residential one.
Here’s a roundup of some of the major differences to keep in mind:
- You’ll generally rent out a commercial property for longer than you would a residential one.
- Vacancy periods for commercial properties are often longer than those for residential properties.
- Commercial tenants usually handle the maintenance costs related to the building.
But it’s the Goods and Services Tax (GST) that creates the biggest difference. You pay GST when you buy the commercial investment property. You also pay it on expenses and income.Usually, this means saving about 10% of the value of the property on top of the cost of the property itself. But you can claim for the GST on your tax returns.
Key Issues to Consider When Buying
There are several key issues to consider before committing your money to a property. These aren’t pros or cons of commercial property investment. Instead, they’re issues to consider when making your purchasing choice:
- Location. Look for a property that offers easy access for public transport. It also needs to offer easy access to drivers, as well as providing access to other businesses. Remember that commercial tenants need to work with other businesses. If they can’t, they’re unable to deliver their services. A location that isn’t conducive to business will not command a very high rent.
- Tenant Quality. Commercial tenants must meet a certain level of quality. Businesses at risk of losing money may fail to pay their rent. Start-ups with a lack of financing fall into this category. The same goes for businesses that are already experiencing money issues. Do your research into the current tenant pool. Work out if it includes tenants that can handle the financial obligation of renting from you.
- Local Infrastructure. This plays a huge part in determining property accessibility. Good infrastructure also supports your tenants’ businesses. Check with local governments to find out more about the current infrastructure. Moreover, research planned improvements. Figure out the effects that they may have on your investment.
- The Building’s Structure. Do not go into commercial property investment without a target client in mind. Remember that the building’s structure must suit the needs of your tenants. It’s no good buying a factory space when your potential tenant pool consists of retail businesses. The more purposes you can use the building for, the larger the number of tenants it will appeal to.
Factors That Affect the Success of the Investment
Several external factors affect the success of a commercial investment. Most of these tie into the economy. They include the following:
- Current Interest Rates. Low interest rates make it easier for you to borrow the money needed to fund your investment. They also make it easier for potential tenants to secure funding for rent. As the interest rate increases, you’ll find it harder to buy new properties and secure tenants for them.
- Different Demographics. These result in changing demands from the local population. This affects the types of businesses operating in a particular region. For example, a retirement community usually needs more health-related businesses. But a Central Business District (CBD) has different needs. Consider the local population’s needs before making your decision.
- Population Growth. As a region’s population grows, so too does demand for commercial services. For example, a flourishing suburb needs shopping malls, recreational areas, and restaurants. This demand for services creates more room for businesses, which also creates demand for your property.
The Final Word
A commercial investment property offers several advantages. You can charge higher rents for longer periods of times. It also often allows you to avoid some of the monthly costs related to property investment. Instead, your tenants deal with them.
But you’ll also deal with longer vacancy periods. Plus, you’ll have a smaller pool of prospective tenants. Moreover, economic factors can either make or break your investment.
Do your research and understand where the demand for commercial properties is. This will help you to make a wise choice that suits the needs of the local business community. In doing so, you’ll enjoy higher demand, which results in stronger yields.