Australia frequently ranks among the top countries for real estate investing, offering investors a choice between residential and commercial properties. With a range of options to choose from, identifying the ideal type of property for your investment portfolio generally depends on intricate cost differentials.
Data from the Australian Taxation Office (ATO) shows that over 2.2 million Australians owned an investment property in 2020-21, collectively owning 3.25 million investment properties. From initial purchase prices to ongoing operational expenditures, financing mechanisms, and prevailing market trends, many factors contribute to the cost of investment that each property requires.
For investors, understanding these costs can provide the best opportunity to invest in the right property that meets their financial goals and creates a lucrative real estate investment portfolio.
In this blog, we’ll take a closer look at the cost differences between residential and commercial property investments, providing insights to help you navigate this dynamic market.
Determining the true cost of residential vs. commercial property investments
1. Initial investment costs
Generally, residential properties require a lower initial investment compared to commercial properties, making them more accessible to individual or first-time investors. Residential properties also have lower acquisition costs as they are often condominiums, single-family homes, or multi-unit buildings with fewer units. Financing options for residential properties usually come with lower down payment requirements, such as conventional mortgages requiring down payments or government-backed loans like FHA loans.
Commercial properties like office buildings, retail spaces, or industrial warehouses generally come with a higher purchase price due to their size and specialised features. These properties could require additional investments in specialised facilities or infrastructure to attract tenants or meet specific business needs. Higher down payments are also required and can range anywhere between 15% to 35% of the purchase price, depending on the lender’s requirements and the property’s risk profile.
2. Rental income potential
Residential properties generally experience consistent demand from prospective tenants since housing is a basic need, whether it’s for an individual or a family. This consistency means that investors or landlords acquire regular rental income even during times of economic downturn. While rental income from residential properties is reliable, the rental yield can be lower compared to commercial properties due to lower rental rates per square foot.
Unlike residential properties, commercial properties have the potential to gain higher rental yields, especially in locations where there’s enhanced visibility and foot traffic. Businesses are willing to pay a premium price for rent in commercial spaces that offer strategic advantages like proximity to commercial centres and transportation hubs. These properties also have longer lease terms compared to residential leases, providing more stable cashflow and reducing the frequency of tenant turnover.
3. Operating expenses
Residential property taxes are dependent on the property’s assessed value and are generally lower compared to commercial property taxes. Maintenance costs can account for a significant portion of expenses as they include routine repairs, upgrades, landscaping, and more to keep tenants satisfied. Landlords could also be responsible for covering certain utility payments such as water and rubbish collection depending on the rental agreement.
Commercial properties may have higher maintenance costs due to the need for specialised repairs, regular maintenance of common areas, and staying compliant with building codes and regulations. Landlords may also be required to bear the cost of tenant improvements or build-outs to customise commercial spaces to meet tenant requirements, especially when it comes to long leases. However, the day-to-day maintenance can save up a lot of expenses as businesses tend to take care of it themselves, saving landlords time and money.
4. Financing options
Residential properties have access to traditional mortgages from banks or financial institutions with competitive interest rates and flexible terms. For first-time residential property owners, FHA loans can also offer favourable terms like lenient credit requirements, affordable down payments, and fixed-rate or adjustable-rate options.
Commercial property financing generally involves commercial mortgages, which may have higher interest rates, shorter terms, and stricter underwriting criteria compared to residential mortgages. Small business owners looking to purchase commercial properties may qualify for Small Business Administration (SBA) loans, which offer favourable terms as well as government-backed guarantees to lenders. Investors can even bypass both these options and opt for private financing options such as syndicated partnerships or hard money loans, to finance commercial property acquisitions, especially for unique or high-risk properties.
5. Appreciation potential
Residential properties tend to appreciate steadily over time, driven by factors like housing demand, population growth, and neighbourhood development. Preferred neighbourhoods with good schools, facilities, and infrastructure often experience higher rates of appreciation compared to areas that aren’t considered preferred neighbourhoods.
Location plays a large role in the appreciation potential of commercial properties. Properties located in thriving commercial districts or high-growth areas can experience significant appreciation. Economic factors like job growth, business expansion, and infrastructure development can positively impact the value of commercial properties, especially in markets with strong demand for commercial properties and limited supply.
Residential vs. commercial property investing: Being clear on costs can help make the right decision
By examining the detailed aspects of the initial cost of investment, rental income, operating costs, financing options, and appreciation potential, it becomes easier to make the right decision when it comes to residential vs commercial property investing decisions.
Whether you’re considering investing in residential properties with their stable demand and lower entry barriers, or commercial property investment with its higher yields and potential for appreciation over time, due diligence, research, and strategic planning can help you find success in the lucrative industry of real estate investing.