Residential Vs Commercial Property Investment: Pros & Cons

Matthew Scafidi
December 1, 2017

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DIRECTOR, AUCTIONEER, LICENSED ESTATE AGENT

As an investor looking to buy real estate in the Melbourne property market, it’s hard to know exactly where, when and in what type of property you should invest.

Ultimately, it comes down to your budget and your investment strategy. We’ve weighed up the pros and cons of investing in residential or commercial property to help inform your final decision, and set you on the path to return on investment success.

Residential property investment – Pros

Growing population & residential property demand = low rental vacancy rates

There’s no doubt that residential property values remain strong in Melbourne. CoreLogic’s National Housing Market Update reported that residential dwelling values have increased by almost 57% over the past five years, being 12.1% higher over the past year alone.

This strong and stable performance in Melbourne property prices is matched with growing demand. In 2016, Victoria’s population grew by an estimated 135,000 new residents – that’s the equivalent of a full MCG plus 35,000 tired, seat less cricket fans.

This combination means that residential investors can price competitively without sacrificing their profit margins or worrying about long-term vacancy.

New construction = less risk of upfront repair and unknown costs

With new property developments comes new infrastructure, meaning there’s a lower risk that you’ll have to dig deep for renovations or structural improvements after your initial investment.

Suburbs such as Blackburn and Mitcham are examples of appealing areas for residential investors as they’re undergoing urban renewal through property development, with new apartment complexes popping up near central transport links.

Residential property investment – Cons

Residential tenants are usually short-term

While the demand for residential properties is strong, it may be relatively short-lived tenant to tenant. Residential leases typically range from six months to one year, meaning you run a semi-continuous risk of vacancy.

However, there’s been a steady decline in Melbourne rental vacancy rates over the past year (recently at 2.1% for metro and 2.3% for regional areas), meaning that this risk is low, especially if your property is in a highly-sought after location.

Melbourne property prices continue to creep up

Getting your foot in the door of the Melbourne property market is demanding a growing upfront cost.

Residential house prices are at record levels in Melbourne and rental yields can be as low as 2%, meaning you may need to look to the long-term for significant yield on your initial investment.

Commercial property investment – Pros

Longer tenancies = less vacancy volatility

Once you’ve secured a tenant for your commercial property, it’s likely this will be for a long-term lease compared to the more volatile occupancy of residential properties.

While lease periods are longer, typically between three to ten years, the minimum deposit required for a commercial property is usually greater, being 30-50% of the property value. There may be additional upfront costs as well due to specialist structural and operational needs of some tenants.

Higher risk, greater reward

With the higher risk of investing in commercial property comes the potential for higher return on your investment in the short term.

When compared to residential properties, the average rental yield of a commercial property is typically two to three times greater. This better initial cash flow however is offset by lower capital growth of the property itself. Knowledge of the commercial property market is key when it comes to allaying risks and enjoying rewards.

Commercial property investment – Cons

Economic conditions heavily influence commercial property values

The commercial market is very reactive to wider economic conditions, meaning that slowdowns in the economy can translate to poor outcomes for commercial property investors. Plus, downturns in commercial real estate tend to be larger in comparison to the residential market.

For example, because of current conditions banks have tightened their commercial property lending standards, meaning it’s increasingly difficult for investors to secure their upfront investment.

Waiting for a long-term tenant can be costly

Since commercial properties are particularly sensitive to the wider economic environment, there’s greater risk that they could be vacant for a longer period compared to residential properties.

Adjusting your property to entice ingrained businesses and fit the needs of different commercial tenants can be a costly process. And as they say, time is money. Or in this case, your return on investment.

The verdict – Residential property investment is a steadier road to success

Investing in residential property remains the safer, less risky option for first-time investors while still providing profit potential in the long run.

However, for investors willing to get stuck into the ins and out of the commercial property market, there is great potential for big returns on investment.

Investment tips for first-time property investors

Regardless of whether you choose to invest in residential or commercial property, this universal advice applies to all first-time property investors.

  1. Know the market

When it comes to investing in residential properties or a commercial property, knowledge is power. Keeping an eye on burgeoning areas of growth and trends in property prices over the long-term can help you to make informed choices and spot profitable property potential.

  1. Know your budget

Unfortunately, the sky is often not the limit when it comes to many investor’s budgets, so it’s important to understand the risks as well as the potential rewards that come with some investment properties.

  1. Know your local agent

Thankfully, you don’t have to be on your own to make the tough decision. At Noel Jones, we make it our mission to support you on real estate journey with our local knowledge and insights. Your dedicated expert will be with you from initial inspections to expanding your portfolio, so get in touch with our local offices today to start your journey.

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