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PROPERTY expert Peter Koulizos looks at the pros and cons of investing in commercial and residential real estate. Courier Mail, Real Estate section.
Question: Which is the better investment?
Answer: It comes down to risk and return.
Residential property is relatively low risk and as a consequence, gives low returns. Commercial property has a higher return but this comes at a higher risk. The major risk in commercial property is a high vacancy rate. In residential property, your property might be vacant for a week or two before you find a new tenant. In commercial property, it may be months or even years before you start getting rent from your next tenant.
Most commercial tenants are involved in business. Not only is rental income from commercial property dependent on the quality of the tenant (as it is in residential property) but it is also heavily reliant on the health of the economy. A healthy economy generally means healthy business and vice versa.
Buying commercial property is often much more expensive and complex than buying residential property. If something goes wrong in your commercial property, you have much more money at stake.
Maintaining commercial property can also greatly affect your cash flow. Renovating a commercial property is not simply a paint job and new carpet. It may also require new air conditioning, refitting of the premises, upgrading of fridges/freezers, removal of asbestos, etc. These renovations are also relevant to residential property but they can cost much more when dealing with large commercial premises.
But with residential, you will have a more difficult time passing on costs. If utility and maintenance fees go up significantly, and you’re bound by a rental agreement, you will end up eating the new costs. This is something you don’t have to worry about with commercial.
As interest rates rise, mortgage defaults may affect the value of surrounding properties, in turn affecting the value of yours.
One of the main reasons people seek out commercial property as an investment is the higher rental returns. A house could provide a rental return of 4 per cent and unit may provide a 5 per cent return. In commercial property, the rent situation is much better. A retail shop could be bought as an investment with a 6 per cent yield, an office property with a 7 per cent yield and an industrial property could provide a yield of 8 per cent. These rental returns are just a guide as some properties will have a much higher or lower rental return, depending on a number of factors, including location, quality of the building, quality of the tenant.
Currently, residential property is undersupplied with respect to demand, which is evidence that residential investments will continue to enjoy capital growth for the time being.
Written by Peter Koulizos, university lecturer, author and buyers advocate.