With residential property prices on the rise across Australia, many investors are turning to commercial property, but why? Commercial property in Australia is defined as property that isn’t residential – these can include retail strips, shopping centres, medical offices, towers, general office and industrial property. Generally speaking, investors choose commercial assets over residential because of the higher yield. It is not unusual for commercial retail property to earn 7% pa, office’s to earn 8% pa and for the right purchase industrial can earn the investor a rental return in excess of 10% pa but what is the return on capital and how much deposit do you need?
What yield would I expect on a $1,000,000 purchase price?
The rental return can ultimately depend on several factors like quality of the building, location and lease term. As with property investment location is a critical factor and plays a large factor in the success of office, retail and industrial commercial property so you should always look for an area offering strong transportation links, a large pool of works and surrounding businesses that can support your potential tenants.
- House – Rent = $40,000 (4%)
- Unit – Rent = $50,000 (5%)
- Retail – Rent = $70,000 (7%)
- Office – Rent = $80,000 (8%)
- Industrial – Rent = $50,000 (10%)
Some commercial properties also serve a limited purpose. For example, if the property has been set up as an industrial cold storage unit – you may only have a limited amount of tenants that will appeal to that property type. Opting for a property with a multi-use appeal can attract a broader range of tenants and help you minimise vacancies.
Who pays the ongoing costs in a commercial tenancy?
Unlike residential investment where the landlord pays all of the outgoings and costs, the tenant pays the outgoings with commercial investment – like council rates, water rates, repairs, maintenance and insurance. Ultimately this means, in the case of a residential landlord, a large proportion of the rental income can be consumed by expenses. In some cases, this can add up to 20% of the total rental.
So why would anyone buy a residential investment property if the return is so much higher on commercial? It is all about risk and return.
Tenant Security, growth and investment risk
With residential investment property, the risk of finding a new tenant is much lower. There are more people in the general public who need a home to live in, compared to commercial where there are a smaller number of businesses that may be suitable tenants. Therefore, the largest risk to commercial property is vacancy. If you lose a tenant in your unit or home it might take one to two weeks to find a new tenant, but if you lose a tenant from an industrial property, it could take months or even years to find a tenant, all the while you need to still be maintaining your loan repayments.
Secondly, retail, office and industrial properties historically have had lower capital growth compared to residential property, whereas residential properties have had lower return as we have highlighted above. So in short, if you’re seeking capital growth then residential property is the best asset, whereas if you are looking for cash flow then commercial property could be more suitable for you.
How much deposit do you need for a commercial property loan?
Using the same scenario as above, you would be expected to pay the following deposit amounts on a $1,000,000 purchase price.
- House = $50,000 to $100,000 (5-10%)
- Unit = $50,000 to $100,000 (5-10%)
- Retail = $200,000 (20%)
- Office = $200,000 (20%)
- Industrial = $200,000 (20%)
- Medical Office = As low as 0%, they will lend up to 100%.
There is a wide range of commercial property loans across the lending market. Typically the banks will provide a lower LVR (loan to value ratio) and require a higher deposit on commercial properties as they are considered higher risk, whereas some smaller and boutique lenders will allow a smaller deposit. Some investors choose to use equity in their existing properties which can reduce the deposit they are required for the new purchase, but will depend ultimately on the individual investors situation.
If you are considering a commercial investment property then you should seek out professional advice from a financial adviser or lawyer to make sure this investment is suitable for you in your current situation. If you have done this and want to look at finance options then talk to the team at Red & Co Finance, they have written over $400m in commercial property loans across Australia and can help you find the best deal in your situation.