Residential vs commercial investing

I recently discussed all the changes occurring in the residential investment sector with a colleague of mine, referring to how much more stringent the rules are becoming for investors to operate rental property. He retorted, “oh, so you’re becoming just like commercial property”.

While there are some similarities in the governance and legislation requirements of both types of property, there are still many major differences between the look and feel of the two. At the recent NZPIF Conference, Joe Chapman, Colliers International Otago Commercial Valuation specialist, and myself, presented on the differences between residential and commercial property.

Commercial investment can come in many forms from large and small scale retail, to office buildings to industrial sites, to syndication parcels where you own just part of a large property. Tenants can vary from large multinationals to small local business operators. The scope is far and wide and selecting what area to invest in will largely depend on your requirements for a return and the amount of resources you have access to.

Residential of course comes in more obvious forms, but can still vary from single stand-alone properties, to terraced property, to converted multiple dwellings or apartments in larger buildings.

The funding models are quite different for each. There is often a higher entry cost to commercial, with lending being typically 50-60% from the bank, at commercial rates of 5% to over 7% depending on the bank and the asset. There can be costs to entice tenants at the start, with rent free periods or fitouts required to suit a particular tenant, but once in the maintenance is usually lower long term. There is often an agent involved in sourcing a tenant for you too with an associated cost.

Conversely in residential, bank interest rates are currently in the 4% range, although the LVR restrictions still only lend to 65% for the main banks. The entry cost is low, with most buildings ready to be tenanted as is and there is often less required and less cost to entice a tenant. Depending on the type of residential, the ongoing maintenance requirements may be higher, especially with the landlord being responsible for exterior and internal maintenance and repairs between shorter tenancies than commercial.

Leases in commercial can range from 2-20 years and are generally more structured, reliable and tenants have lesser requirements ongoing than residential. While sourcing a tenant is cheaper in residential, the ongoing requirement to attend to their needs, especially in the Dunedin student sector, can be quite high and then every year you have to repeat the tenanting process. Commercial tenants rarely request a light bulb replacement and almost never call after hours.

The wider economy however does pose more risk for commercial investments. When economic downturns occur, naturally some commercial tenants struggle to survive the event or have trouble paying the current rent and need reductions. Retail can struggle in this area, but the flow can quickly move to office and industrial tenants too. Residential doesn’t have quite the same direct effect and is cushioned by the fact that people simply still have to live somewhere. It is often more important in these times to understand tenant migration patterns. For example, often universities fare well in recession times as more people either move or remain in study while the job market is low. In some sectors, negative economic events can positively impact residential investment.

Finally, the returns on property do differ between commercial and residential. Depending on the type of commercial and the prime or secondary locations, net returns can float between 6.5% – 11%. The student residential market will sit around 5%-6% net return for shared tenancies and for studio tenancies with communal facilities, often 6%-8% net return can be found.

A further type of commercial investment not often in the limelight are syndication investments. These are a way to access ownership of much larger multi-million dollar commercial investments. Investors purchase ‘parcels’ in the property, a similar concept to buying shares in the company. A parcel might be worth $50,000 to $200,000 each and dividends are often paid out quarterly and it is not uncommon to see a 7%-8% pre-tax return at the initial sell-down of a syndicated property. Properties might be large scale industrial sites, shopping malls or office buildings, often with multiple large tenants and long leases secured in place. A management company is put in place to operate the investment long term. Parcels can be sold in online portals at any later stage for whatever the market rate is being accepted at the time by another investor. This is a very passive hands-off approach to investment, and often taken up by investors that have sold up their active investments over the years and are looking to keep money in the property market, without having to do all the work.

If you choose to look more closely at commercial property, we recommend talking to your accountant and solicitor in the first instance to get advice on what you should look for in your particular situation. Then happy hunting sourcing the best investment for you.

This article does not constitute investment advice and further independent advice should be sought.

Matt Morton is a specialist Dunedin residential investment broker for Colliers International.