Most investors feel comfortable with investing in residential property, as they are familiar with it. Most of us have rented a property, and some of us have bought a house or unit, and understand what that experience entails.
Commercial property, on the other hand, is a little more mysterious, but is an increasingly valid investment option for buyers in the United States.
There’s a little more to commercial property, including terms and conditions of commercial leases, and who is responsible for the outgoings (expenses) of the building.
Here’s a break down of the key risks and factors to consider.
Commercial property comes in three main forms, office, retail and industrial.
Residential property investment is relatively low risk and as a consequence, low return. Commercial property has a higher return, but this comes at a higher risk. For example, a flat or unit will average a return of 5%, whereas industrial property, such as a warehouse, may average 8%.
The higher risk comes in the form of higher vacancy rates. Let’s use the warehouse example. It could take a while to find a new tenant for the warehouse, many months and possibly more than a year. Conversely, finding a new tenant for your residential property might only take weeks. Additionally, if the sole tenant of your property has to close due to tough economic conditions, you could face some hard times. On the other hand, residential property can be resilient when it comes to economic factors over the long term.
Duration of leases
Residential leases tend to be about 12 months. However, commercial property leases are generally for a much longer period of time. It is not uncommon to have leases that are for an initial five-year period, with the option to renew for another five years.
Quality of tenant
The tenant is obviously a crucial part of your property investment. In commercial property, a government or large corporate tenant is considered a ‘blue chip’ tenant. They are likely to rent your property for a long period of time and are unlikely to default on the rent.
High cost of entry
Buying commercial property is often much more expensive than buying residential property. CBD office or retail space is generally the most expensive space, due to its locality. Industrial property on the outskirts of the city can also be expensive due to size of the property being purchased. Costs, however, can minimized by purchasing smaller strata title premises.
Upgrading a residential property is relatively cheap. A paint job, new floor coverings, kitchen and bathroom can cost as little as $20,000 to $30,000. Refurbishing a commercial building, however, can be costly. New air-conditioning, upgrading the building to meet new health and safety standards and refits may cost 10’s or even 100’s of thousands of dollars. However, the costs are rarely the responsibility of the owner.
One of the advantages of being an owner of commercial property is that the tenant usually pays most of the outgoings, such as insurance, repairs and maintenance. This means that most of the rent collected by the owner can be kept unlike the situation with residential property where the owner uses the rent money to pay for rates, taxes, maintenance and repairs. All the details of who pays the outgoings, how much rent is owed and how often it is increased should be outlined in the lease.
This is the most important document in relation to commercial property. Unlike a residential lease which is commonly a standard document and about four pages long, commercial leases are often 50 to 60 pages in length, are not standard documents and generally need a solicitor to draw them up.
Read the lease carefully and if you are unsure of anything, ask a legal professional to explain it to you.