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26 Sep 2013

Residential vs Commercial

 

As there are many existing and budding investors in the marketplace today I thought it may be valuable to analyse the residential versus commercial property question.

 

Every kind of property investment can offer great rewards but also come with its own share of risks. The quick answer is that both types of investment can work in its own way but the one that suits you better largely depends on your financial circumstances, business knowledge and personal investment goals.

It is considered that one of the biggest advantages of commercial property investment is the potential for higher rental yields whilst the biggest advantage with residential is higher capital gains. Either of the options have tax benefits such as negative gearing, depreciation and reduced CGT rates and both enjoy the status of low volatility.

The majority of Australian investors focus on residential property because we’ve all been renters or owner-occupiers so we’re naturally more comfortable dealing with residential investment.   Consider this a crucial point – as an investor, you need to be able to live as stress free as possible, so comfort is always a priority.

However, if you’re curious about commercial property, then you may be starting to think differently and that’s great.   You really need to be a savvy business person to invest in commercial assets.  You need to be able to analyse a prospective tenant’s financial viability as this can have a significant impact not only on your rental returns but also on the value of the property.

Here is a list of Advantages and disadvantages:

 

Advantages of residential property

  • Larger choice of investments with more residential properties available for purchase.
  • High access to credit and leverage –and at lower interest rates with residential property. Many lenders are lending 95 per cent again.
  • Significant performance data – residential property prices have been monitored for over a hundred years, providing greater investment certainty
  • Significant amount of ongoing analysis – Easily track and create forecasts on your residential investment, such as Australian Property Monitors or RP Data.
  • Growing rents/yields – strong demand for property and rising population gives rising yields.
  • Short vacancy rates – provides higher confidence of receiving the forecasted rent/yield.
  • Good capital gains – residential property has enjoyed stronger historical capital gains.
  • Self-managed super funds – you can now buy a residential property with leverage in a SMSF.
  • Offshore demand – there is an increasing demand from Asian investors for Australian property.
  • Rising investor demand – the current high demand is contributing to capital growth.
  • It’s a lot simpler – landlords can rely on a property manager to find someone who wants to live in the dwelling. The demand from tenants is strong so if one tenant is unable to pay their rent, a new tenant can be sourced quickly with minimal involvement from the landlord.
  • Property shortage – residential property is currently undersupplied and this is a key reason why residential will continue to enjoy capital growth at least in the medium term.

 

Disadvantages of residential property 

  • Lower yield – lower annual returns with average yields approximately three to five per cent.
  • Rising interest rates – deterioration of the return on investment and possibly even losses.
  • Mortgage overhang – as interest rates rise, mortgage defaults may result in an increase to supply which will affect the value of surrounding properties.

Advantages of commercial property

  • Higher yields – higher annual returns than residential property with average yields ranging from five to 10 per cent depending on the type of tenant and the terms of the tenancy.
  • Business owner benefits – Business owners can take advantage of buying the premises they need to occupy. Some great tax advantages can be found doing this.
  • High access to credit and leverage – banks are comfortable to lend but at a reduced level compared to residential – usually 80 per cent compared to 95 per cent LVR with residential.

Disadvantages of commercial property 

  • High level of expertise required – you have to understand credit assessment to analyse the likelihood of a tenant being able to pay the rent. This includes reading tax returns and business plans.
  • Value of property depends on tenant – the credit assessment is directly linked to the valuation of the property, so you must get this right or risk losses.
  • A large number of start up businesses fail. Furthermore, a business may have done well in one location but that doesn’t mean it will be reflected in another.
  • Smaller choice of investments with fewer desirable commercial properties available to purchase.
  • Low capital gains – on average, commercial property has not enjoyed the same historical capital gains as residential.
  • Higher vacancy rates than residential property.

 

To discuss this further, contact Alert Property Group today.

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