As you probably know, if you've been reading my articles, or listening to my podcasts, I'm pretty gung-ho about commercial property. Mostly because of the cash flow.
But I wanted to make some direct comparisons to really drive the point home.
If you invest in residential property – or don't invest yet but are thinking about it… consider this:
An investor who owns residential property would consider themselves lucky if they could get a rental return of 4% pa on a house and 5% pa on a unit/flat/townhouse.
If you were looking for cash flow you'd be crazy to think that that was going to get you where you want to go.
Those numbers are too close to teh interest rates you'd have to pay the bank for the loan.
But now let's look at commercial.
It’s not uncommon for retail property to earn 7% pa, office property 8% pa and in some cases, industrial property can provide the investor with a rental return of over 10% pa.
Let's take a look at the kind of returns you can still get with commercial over five different types of property. Let’s assume that the purchase price is the same for all, at $500,000.
Purchase Price – $500,000
House – Rent = $20,000 (4%)
Unit – Rent = $25,000 (5%)
Retail – Rent = $35,000 (7%)
Office – Rent = $40,000 (8%)
Industrial – Rent = $50,000 (10%)
The rental return can vary depending on a few factors, such as location and quality of the building.
A higher percentage rental return is only one of the advantages so far as rent is concerned.
A residential investor has many expenses. They need to pay for council rates, water rates, repairs, maintenance, insurance, property management fees and the list goes on.
This means that a large chunk of the rent (up to 30%) that the residential investor receives is spent on expenses. When you're looking for cashflow that can be a big hit to that goal.
But… If you invest in commercial, the tenant pays for the vast majority of expenses including council rates, insurance, property management fees, etc.
It means that the commercial property investor may only need to pay out 5% of the rent received in expenses depending on how you negotiate the lease.
So here's another example that illustrates the differences between gross and net rent. Gross rent is the rental amount that the tenant pays the landlord and the net rent is the amount of rent the landlord is left with after paying all the property expenses.
Again, same deal… Let’s assume again that each property cost $500,000.
Residential Property (rental return – 5% pa)
Gross Rent – $25,000
Net Rent – $18,000
Commercial Property (rental return – 8%)
Gross rent – $40,000
Net rent – $38,000
It's a big difference, and you may be asking why would anyone invest in residential given those numbers?
Well, there are a few reasons.
Residential is what most people know. Very few people spend the time or money getting an education in how to successfully invest. They just get told by their accountant to buy an investment property, and residential is the only thing they know.
Secondly, those who do start looking into it often come across myths about commercial that it's high risk and that you get more capital growth from residential.
Well, let me tell you that, again, it comes down to education. The supposed risk in commercial is in long vacancies. When you choose your property, correctly that becomes a non-issue. I've had some tenants that have stayed for over 20 years. There are nice long leases in place which makes for a very stable investment.
Secondly, if you have the right property capital growth can be manufactured, not only more quickly than residential but in greater quantities.
You have to remember that commercial properties are in commercial zoning. Which means that there is often much more you can do with a block of land in that zoning than you could ever do with a residential block.
Where to start I hear you ask?
Your first step is to get educated. There's a right and a wrong way to get started in commercial investing, and you don't want to get it wrong. There are certain rules to follow, that I still follow to this day, and specialised due diligence that you should be doing.
The main things you need are these:
Education – (Check out my online webcasts training),
A good finance broker who understands commercial,
…And A good solicitor that deals with commercial property and you'll be well on your way.