When it comes to people or journalists talking about the “property market, we often tend to refer to residential property. Primarily because residential property is something that we all are familiar with: we all live in houses or apartments, and most of us have bought a house or apartment at one time in our lives.
You likely skim through articles related to property market trends and news in your news feed in social media, and in most cases this will be related to residential property. Investing in residential rental property appears the easiest and most obvious answer if you are considering property investment. But is it really?
Did you know the residential and commercial property markets are two very different markets? They don’t always follow each other. It is possible for one market to be slow or performing poorly, and the other to be doing very well.
This is Part 1 in a series of articles in which we explain the difference between residential and commercial property and their markets, how to evaluate whether you should look to invest in residential or commercial property, how to evaluate a potential property investment, and other matters that all property investors should be aware of.
Most importantly, we will provide the reader with the more knowledge so that they can form their own view that anyone can safely invest in commercial property – it is not just for very rich people or big companies. You too can invest wisely and make good money in commercial property!
What are “residential” and “commercial” properties?
Residential property in New Zealand is legally defined as “property used, or intended to be used, exclusively or principally for residential purposes”. ie., houses, townhouses or apartments. You can live in the property yourself, or you can rent it out and enjoy rental income.
Commercial property is property that is used for various non-residential activities: offices, retail shops, industrial buildings, public facilities, hotels, etc. Similar to residential property, you can operate your business from your commercial property, or you can lease it to one or multiple tenants. Most businesses prefer to rent rather than own the property they operate their business from, so the commercial property market is a large investment market.
A typical small warehouse investment property
Investment return for commercial and residential properties can be very different, as well as the risk profile. The right property for your investment depends on your situation and investment goals:
- To what extent would you like to be involved in your investment?
- Is it short or long term?
- What is your resident visa status? If your visa doesn’t allow buying residential property, then maybe consider commercial property to invest your money?
- Is it going to be your single investment or a part of your portfolio?
- How does your financial situation look like?
- Would you like high return (and higher risk) or safe low return (and lower risk)? Or somewhere in between?
It is not always easy to evaluate the risks of investment, however, being aware of some general differences between investing in residential and commercial property will assist you in decision making. We will briefly cover these below.
Commercial properties investors in New Zealand generally enjoy higher returns compared to residential property investors. Whilst the yield of residential property widely varies across the country (from around 4% in Auckland to up to 8% in Dunedin), commercial property returns can be over 10% (Morgan Stanley Capital International indexes, 2017).
Investment return comprises two components: (i) the rental cash income; and (ii) the capital growth return (the increase in property value).
Some investors prefer high cash (rental) return for income – usually high income return (or yield) properties have lower capital growth rates than other properties.
And some investors are OK to not receive regular cash income and invest in properties that have high potential to grow in value (capital growth).
We will explain more about investment return – yield and capital growth rates – in future articles. Follow us to learn more.
Leases & Tenants
If you own a residential property, your tenants will be individuals: families, couples, retirees, students, etc. Commercial tenants are companies, varying from small family businesses to large international enterprises.
Leases for residential property are usually 6 to 12 months, so if you get a bad tenant you can usually change them for a better tenant quite soon.
Leases for commercial property can be anywhere from 1 year to 15 years, but usually around 3 to 5 years with the tenant having the right to extend the lease if they wish to.
So, for commercial property it is very important to make sure you get a good tenant because you will have them for a long time!
Finding the right tenant
For residential properties, your tenants can be basically anyone, to whom the property appeals and who can afford it. Location, size and condition of the property and rental price will be the main choice criteria for your prospective tenants. Obviously the better quality of the property, in a good location, and not too expensive will mean your residential property should always remain in demand with tenants.
Commercial property tenant options will be limited by the property type: retail, office, industrial, hotel. Your tenants will also have to consider additional criteria: whether the premises would suit their business needs; any special features of the premises that the business may require; zoning of the property, number of car parks etc. In selecting a commercial investment property, most investors will try and select one that appeals to a wide range of tenants in all stages of the economic cycle.
Be very careful and diligent in choosing your tenant! You want your property to be treated well and your rent to be paid on time! It can be very difficult to make a bad tenant leave, best to always get a good tenant!
Residential tenants only pay rent, power and water bills. As a landlord, you will be responsible for all maintenance and repair costs, council rates, insurance and body corporate fees (if any). Also, if you pay a Property Manager to manage your property for you, this will usually cost around 9-10% of the annual rent (usually 7.5% of rent plus various fees).
Commercial tenants pay “base rent” plus cover the outgoings costs as agreed which usually includes council rates, insurance and body corporate costs. The Landlord of a commercial property usually pays less ownership costs (outgoings) than the Landlord of a residential property. Also, Property Manager fees are usually lower at around 5.5-7.5%.
Residential tenants may be tidy and maintain the property in good condition. They will not be responsible for any renovations or improvements to the property.
Because commercial tenants usually lease the property for a long time and need it modified to suit their needs, they often pay for their own improvements such as refurnishing the offices, repainting, installing new lighting etc. Often a commercial property can be left in better condition at the end of the lease than when the tenant started the lease!
We have highlighted just a few points that illustrate how residential and commercial property investment are quite different. In our series of articles we hope to help people better understand commercial property and be less intimidated by it – it is not difficult or complicated, it is just different!
We will share the many reasons why commercial property investment is an opportunity worth considering, especially in Auckland where residential market is weak and prices are dropping, but also in other parts of New Zealand, even if you are new to the world of property investment. Investing in commercial property, you can enjoy higher returns of investments and pursue long term capital growth. Commercial property investment will also suit new immigrants, whose investment goals include securing a New Zealand resident visa through investment.
To learn more about property investment opportunities in New Zealand contact us:
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