It’s taken a while, but you’ve finally got enough funds saved up to think about investing. Like a lot of people, you’ve decided property is the way to go. And now you’re scouting out houses, units, and other residential investment opportunities.
But here’s a question for you: Have you looked into investing in a commercial property instead?
Chances are you’ve either never considered it or, if you have, figured it’s only for experienced investors. But you really should think about it, because investing in commercial property has a number of advantages compared with investing in residential property.
Here are five reasons you should at least look into it.
1. Lower risk and lower vacancy
A lot of people think investing in commercial property is risky compared to residential property because the numbers are larger. But if you apply due diligence and follow some key points (such as making sure it’s in a good location), that’s not necessarily the case.
And while finding someone to rent a house or unit can be pretty hit and miss, some commercial properties haven’t been vacant since our clients bought them. Others have been vacant from time to time, but the owners recouped their rent losses by re-leasing them at a higher rent. You may even have an arrangement where your business is the tenant, giving you guaranteed rent for as long as you stay in business.
2. Higher rates of return than residential properties
Whatever kind of property you buy, it’s important to know the net return— the return (shown as a percentage) of the rent to purchase price after deducting costs such as agent’s fees and other fees and charges. The trick is to buy a property where the net return is higher than the loan’s interest rate. The bigger the difference, the bigger the cash flow it produces.
Once you subtract the running costs (outgoings), the net return for most Australian residential property investors is only 3-4%. But the net return on a commercial property is generally 6-8%, with some going as high as 12%.
Important note: Calculations on commercial investments follow a pretty strict formula, with outgoings being deducted from the gross rent to give you a net return. A lot of residential investors delude themselves by not calculating their returns properly (i.e. not allowing for the cost of all their outgoings).
If you are borrowing 100% of the funds, you want your properties to be cash flow positive from day one. So if you’re paying 7.6% interest on an interest-only loan, you want that property’s net return to be at least 7-8% in the first year. Of course, if you use the equity of another property, or cash savings as a deposit like your superannuation, you’ll get the same return on those funds as well.
3. You can maximise your net return on an ongoing basis
This income stability you get with a commercial property investment means you can confidently reinvest in a way that’s pretty much ‘set and forget’. You should then analyse your figures at set times through the year to maximise your return.
And as the years go on, your return (compared to the purchase price) will go up. The lease will include details of a yearly rent increase based on either the Consumer Price Index (the standard for commercial properties in Australia) or a nominated amount.
4. Tax and depreciation benefits
Commercial property investments provide great tax and depreciation benefits. You get them with residential properties as well, but physically larger commercial buildings give you a proportionally larger amount.
Why? Because commercial spaces are usually made up of large floor areas, a kitchen or morning tea room, and some toilets. That means air conditioners and other plant equipment (machinery and movable equipment in the building) can be easily listed and quantified. I use a depreciation specialist such as Property Returns, who then automatically include Bricks & Mortar in all correspondence and reports.
The depreciation allowance effectively increases your cash flow. But while the tax benefits are great, they’re never the sole reason why you buy a property.
5. Banks like lending money for good commercial properties
Banks almost always lend money for a commercial property if it’s in a good location and has a good lease in place. Always look at a property from a lender’s point of view—it will improve your chances of getting the necessary finance. And the fact you’re interested in a commercial property means you’ll probably be dealing with someone at the bank who’s a lot more business focused.
So there you have it: five advantages to investing in commercial property instead of residential property. But we’re not finished yet. In our next blog post we’ll tell you about five more advantages investing in commercial property will give you.