There are considerable differences between commercial and industrial properties compared with residential real estate.
The main ones can be summarised as follows:-
1. Commercial properties tend to yield a higher return than residential properties – usually between 7% and 10% net; compared to residential properties which yield 3.5% to 5% gross (then you still have to pay the rates, taxes, insurance, etc.) The professional investors require a higher rental return from their commercial properties to make up for the longer vacancy factors and potentially higher risks and possibly poorer capital growth.
2. With commercial properties the tenants usually pay all the outgoings such as rates, taxes and insurance, while with residential property the landlord pays these.
3. Leases for commercial properties tend to be for longer periods, often 3 to 5 years as opposed to the one year lease you get from a residential tenant.
4. 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.
5. I find commercial properties less management intensive – in fact we manage our own commercial and industrial properties, but I hand over the day to day management of our residential properties to a property manager – I don’t want to be bothered with leaking taps.
6. 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.
7. 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 centers, but they will usually have secondary tenants who are more likely to go broke and leave you with a vacancy.
8. Interest rates for a loan on commercial properties are usually higher than for residential properties- at present about 1% higher.
9. 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?
10. 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.
11. The lease required on a commercial property is much more complex and usually requires a solicitor to prepare it.
12. 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.
My own personal experience owning a number of commercial and industrial properties is that while we have had no vacancies over the last 15 or so years (as one tenant moved out another moved in because we have owned the right type of property and manage them ourselves), our capital growth on these properties, even though they are in prime positions, has been poor compared to the growth of our residential properties.
In general I believe residential property is a safer choice for the beginning property investor, but as you become more experienced and have more substantial assets you could consider adding commercial properties to give your portfolio some balance.
