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The pros and cons of investing in commercial property

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Property is a popular investment choice for many Australians, with the majority preferring to buy houses and apartments. However, a minority of investors put their money in commercial assets such as offices and shops.

There is a considerable difference between the two, and both have their advantages and disadvantages. So in this guide, we break down some of the pros and cons of investing in commercial property when compared to residential.

Pros of investing in commercial property include

Higher rental yields

Commercial properties typically offer higher rental yields than residential. For example, in December 2019 the average rental yield across Australian cities for residential properties was 3.9%. In contrast, commercial properties generated an average yield of 7%.

Longer leases

It’s not uncommon for commercial tenants to sign long-term leases of three or more years in length. That’s because many businesses want the stability that comes with a longer lease.

Lower outgoings

When you’re a residential landlord, you often have to foot the bill for council rates, land tax and any body corporate fees. But with commercial property, the tenants typically pay these expenses for you – leaving you with just the mortgage to worry about.

Portfolio diversification

We’ve all heard the advice that you shouldn’t put all your eggs in one basket. So some investors like to diversify their portfolios by adding commercial property to their mix.

Cons of investing in commercial property include

Long vacancies

Commercial tenants are harder to come by than residential renters. As a result, it’s not uncommon for commercial properties to have long gaps between tenancies. When the property is empty, you have to cover all the costs without the support of rent. So it’s a good idea to have a large cash buffer on hand that you can draw on during these periods

Larger deposits

Most lenders view commercial property as riskier than residential so often their loan to value ratios (LVR) on commercial mortgages are a lot lower than home loans. That means you have to stump up more cash for a deposit.

More vulnerable to economic shocks

Demand for commercial property tends to fluctuate depending on the strength of the economy. That’s great news when it’s booming, but less so when it’s a downturn. While residential property can also be susceptible to economic conditions, people always need a place to live.

Values can drop quickly

The value of a commercial property is closely linked to the strength of its leases. So when it’s vacant or a lease is about to expire, the property’s value could well fall.

Do your research first

Just like residential property, not all commercial property is a good investment. To further complicate the issue, there are many types of commercial property too such as retail, offices, warehouses and factories.

With so many variables at play, it’s wise to do your research beforehand as well as get financial and legal advice. This will help you decide whether your money is better off invested in commercial property, residential property or another asset class. One isn’t necessarily better than the other, and which is most suitable for you depends on your individual circumstances.

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