I often get asked, “It is better to invest in commercial properties or residential properties?” What do you think?
To me, these two types of properties can be a good investment opportunity, but it all depends on what’s the aim of the investors as both of these asset classes will help investors to achieve different type of objectives. Smart investors in the market don’t choose between the two: They look at both to see how it may fit into their overall portfolio.
Generally, commercial properties often offer more financial reward as compared to residential properties, but there also can be more risks involved. Understand the pros and cons of investing in commercial properties are important so that you can make a better investment decision.
PROs of Investing in Commercial Properties
Below are some of the pros of buying commercial properties over residential property:
Higher returns on investment
Commercial properties generally have a higher return (between 6% and 12% of gross rental yield). Furthermore, commercial properties can double its price in a short period of time (normally between 3 to 6 years) whereas residential property might take between 7 to 10 years to reach the same percentage. This will highly depends on the location of the properties.
While a residential tenancy can turn over every 3 to 6 months, a commercial tenancy can be anywhere between 2 and 10 years. Tenants tend to stay longer especially when they’ve invested some capital on renovating the premises and moving a business is a lot more complicated than moving a household.
Properties will be well-maintained
Retail tenants will normally spend some money on renovation to suit their business needs and also to maintain their store image, because if they don’t, it will affect their business. As a result, commercial tenants and property owner interests are aligned, which helps the owner maintain and improve the quality of the property, and ultimately, the value of their investment.
Research shows that the tenants of commercial properties are mainly companies or large corporations as compared to the tenants of residential properties which are mainly individuals. The tenants for commercial properties will be more reliable and they tend to pay the rental on time and the possibility of breaching the tenancy agreement is less.
For residential properties, tenants normally prefer fully furnished units whereas for commercial properties, furnishing is not necessary. This might save up some of the renovation and furniture cost.
CONs of Investing in Commercial Properties
While there are many positive reasons to invest in commercial properties over residential, there are also some of the following issues to consider:
Bigger Capital Outlay
Acquiring a commercial property typically requires more capital up front than acquiring a residential property mainly due to 2 reasons:
- Commercial properties are generally more expensive and
- The percentage of loan granted for commercial properties by most of the financial institutions is lower as compared to residential properties where you can easily get 90% loan financing.
The rate of quit rent and assessment, utilities bills (water and electricity) for commercial properties are higher as compared to residential properties.
Interest Rate & Strict lending Condition
Interest rates of commercial properties loan are generally higher as compared to residential properties.
If you own a commercial retail building with a large number of tenants, you might need to spend more time on managing your tenants.
While commercial property often looks attractive on paper, there are potential risks that you need to take into consideration before investing:
- Commercial properties are generally sensitive to current economic conditions. When the economy is strong, businesses is expanding and the demand for commercial properties generally rises. But when there’s an economic downturn, demand for commercial premises usually falls and it will take longer time to find a new tenant. The unit might be vacant for some time too and you will need to cover all the cost during this period.
- Changes in supply conditions can create potential problems for investors. An increase in supply of new properties in the same area creates a threat to existing tenancies as tenants may look to upgrade or expand their business. If supply is greater than demand, this will also causes reduce in rental yields.
- Commercial properties will be affected by changes in infrastructure.
- Commercial properties is less predictable than residential properties with the potential for longer vacancy periods
So, should you buy commercial or residential?
It largely depends where you are now in your property investment portfolio. If you’re looking to diversify and want a cash flow injection, a well-located commercial property might be your good consideration. Always make sure that you do a thorough due diligence and understand the risks involved.