Residential VS Commercial Property
Skip a full scale commercial property investment guide, learn everything you need to know about investing in commercial real estate versus residential right here.
Commercial and residential construction vary in almost every way, ranging from the building materials equipment required through to the way funding is secured.
The key differences lie within the way residential properties are used compared to commercial properties. Put simply, residential refers to buildings that are designed to be lived in while commercial refers to any property used for business activities.
When investing in residential real estate, landlords must source tenants to live in their rental property and pay rent each month. Upon reviewing tenant applications, landlords must review the prospective tenant’s previous rental history, credit, income, and various other details about their background to ensure they will be responsible, long-term tenants who will care for the property.
It is recommended to market to longer-term renters as it decreases tenant turnover and mitigates any stress of sourcing a new tenant for the landlord. In the same vein, long-term renters are more likely to treat the property as a home in terms of maintenance and general upkeep. These types of renters provide a steady financial income to investors as well – a key factor for successful wealth creation.
In contrast, businesses commonly lease commercial properties and leverage a commercial lease agreement. Lease agreements are more complex at the commercial level and can include absolute net leases, triple net leases, modified gross net leases, and full-service leases.
What are the key differences I should know about?
Lease Length & Vacancies
Commercial properties have much longer leases than residential properties, and it’s much harder to replace a commercial tenant than a residential tenant which results in longer vacancy periods. During these periods, commercial investors are often required to cover their property’s outgoings without rental income.
While there’s little variation between lease types, commercial leases are created with the help of lawyers and financial advisors, meaning that they can vary extensively as all terms can be negotiated.
The average yield on commercial property is typically from 5-12% while residential offers 3-4%, meaning commercial properties will likely be cash-flow positive.
Most commercial leases include fixed annual rent increases of between 3-4%, whereas residential rent increases are generally influenced by supply and demand, comparative markets and the availability of a substitute.
Commercial tenants often sign ‘net leases’ that make them accountable for paying land tax, council rates, insurance and of course maintenance. As a result, commercial investors need more available capital growth than residential investors.
Commercial investment is a much higher risk than residential investment. As a result of this, banks usually require a minimum deposit of 30% as opposed to 20% for a residential deposit. Additionally, commercial loans also attract higher interest rates and administrative fees.
As demand for all businesses experiences peaks and troughs, it also echoes through demand for commercial property, making it much less stable than residential property. With high return generally comes higher risk.
There is a common thought that investors don’t get capital growth out of commercial property, but this couldn’t be further from the truth. It’s all about supply and demand, with ratios and fundamentals that are just like those of residential investments.
Applying for a Mortgage
To buy a commercial property, investors must apply for a business loan and provide a business strategy along with its affiliated profit forecasts. As outlined earlier, the deposit will likely be at least 30% of the property’s lender-assessed value and investors will incur higher interest rates and administrative fees.
The Bottom Line: Which One Should I Invest In?
If you’re new to property wealth creation, it is strongly advised to purchase a residential property as it involves much less risk, is more achievable to acquire financially and is generally easier to understand.
However, if you’re an experienced investor with a successful portfolio of residential properties, a commercial investment may be a worthwhile consideration. With the additional risk involved, it is crucial to consult a Property Wealth Creation professional to ensure this purchase will improve the performance of your property portfolio and ultimately, increase your cash flows.
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