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Residential Or Commercial Property Investment?

Residential property investment has been the primary focus for most property investors in New Zealand as it is an easily understood form of investment, carries with it less risk of vacancies and can be more readily saleable in a depressed market.

For these reasons commercial property investment has been largely overlooked by many investors; even though this class of property can provide you with much greater levels of return than that from a purely residential investment. An immediate benefit to the owner is that commercial tenants pay for outgoings on the building such as insurance, rates, building Warrant of Fitness fees, repairs and maintenance and often management fees.

As a property investor, if you are looking to diversify your residential investments, then commercial property would be the next logical step. However, it is true that residential investors are often wary of entering the commercial property market due in part to their lack of understanding on the driving factors behind commercial investment and perceived risk in re-letting a property should it become vacant.

Vacant commercial properties have certainly suffered more than residential in the past when it comes to finding a tenant and prolonged vacancies can occur. Furthermore, getting a new tenant signed up can be expensive. Agents fees of 13% to 15% of the first years rent, and inducements such as a rent holiday and/or help with fitout costs are often expected.

It is important therefore that you have a lower level of borrowing than you would for residential so that you can ride out any prolonged vacancy. With this in mind, banks typically only loan up to sixty percent of a commercial property’s value anyway.

Commercial property investment has always been focused primarily on location however of equal importance is the associated tenancy that runs with the property as this provides the source of income for the investment.

The strength of a tenants covenant to meet their lease obligations and pay the rent is one of the most important issues in commercial property investment.

Coupled with this the length of lease term is also paramount. Long term leases (six to ten years plus renewals) are very sought after as they give you, the property investor, a much reduced risk profile of having an empty building, particularly when a sound tenant covenant is also provided.

Other important factors you should consider include location to ensure the building is well positioned to local service centres, is accessible to main roads or motorway systems and can ideally benefit from visibility and profile to passing traffic. As a landlord, you must ask, could the building be re-let easily and efficiently should the existing tenant vacate?

Buildings should ideally be adaptable for a range of alternate uses to meet future tenant requirements. Specialised property lack this attribute and are therefore more at risk of long term vacancy if a tenant is lost.

Multi-tenancy premises are well sought after by investors as they provide a good spread of income and reduced risk associated with having any vacant space compared to a single tenanted building. However, they do carry with them more management issues. commercial properties

Any property investment should be viewed as a long term strategy and as a commercial investor you will find that over time you will have seen rents rise significantly more than a similar residential investment. When economic times are good, rapid increases in rental levels have been seen. With most lease agreements providing for two yearly rent reviews, this can lead to a significantly higher rent roll and value of the property over time.

The current low interest rate environment has meant that positive returns on commercial investment are now being enjoyed where the costs of borrowing may be say 6.5% whereas the return on the commercial property investment could be around 9.0% to 10%. This additional margin of 3.5% is likely to attract greater interest in commercial property.

Having a long term view on any property investment is important as there will certainly be some downward fluctuations in value when economic times are hard such as now. However, in the long run property investment has historically given some of the best results out of any investment strategy.

 

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