For many residential property investors, commercial real estate presents as a risky, complicated and costly option. This couldn’t be further from the truth. With the right knowledge and support, investing in commercial property can be a great asset to your portfolio due to often higher rental returns, longer-term tenants (leases) and fewer expenses on property maintenance (as tenants often cover these costs).
As New Zealand property investors, we are confident with buying residential property; however, we need to learn that investing in commercial property is a similar process, and it can come with significant benefits. Recent commercial property sales data shows the commercial property sector is fast becoming a popular choice for property investors.
Considering New Zealand’s residential market and the new regulations, many residential investors are considering adding commercial property to their portfolio. For a number of years, I worked as a residential agent with a focus on residential investment properties, in particular apartments and unit titles. This was an area that most agents stayed away from due to the amount of paperwork involved when dealing with body corporates.
While working in the area, I could see that the writing was on the wall for residential landlords as the levels of compliance were only going to increase, resulting in tighter margins, lower returns and higher risk.
In 2016, I shifted my focus from residential sales to commercial sales and leasing - I’ve never looked back. The advantages for an investor are far greater, now, more than ever, with the regulatory changes in several areas heavily impacting residential property investment, as well as market pressures. Below, highlights the upside for commercial versus residential property investment.
THE BRIGHT-LINE TEST RESIDENTIAL - There have been ongoing discussions that the Government will extend the bright-line test from five to 10 years. This particularly affects anyone making a profit out of flipping houses. You will effectively be charged a “capital gains tax” at the highest income tax rate on the profit you make out of the sale of any property that is not your permanent residence.
VERSUS COMMERCIAL - There is no bright-line test on commercial property. You can buy, sell and trade as often as you like, without the risk of the Government getting their hands on your hard-earned cash.
HEALTHY HOMES STANDARDS RESIDENTIAL - All residential rentals must comply with the Government’s Healthy Homes initiatives. Compliance requirements include ceiling and underfloor insulation as well as ensuring that residential properties have adequate heating, in accordance with the World Health Organization (WHO) recommendation of a minimum indoor temperature of 18˚C. There are also requirements for rangehoods over the oven, extractor fans in the bathrooms and more. Not to mention the controversial tenancy law reforms resulting in a number of changes to the Residential Tenancies Act 1986 (RTA).
VERSUS COMMERCIAL - There are no Healthy Homes standards for commercial property. You do, however, need to follow local council guidelines depending on the type of tenant you have in place. But, if the incoming tenant has specific requirements, it is usually the tenant who pays for this work to be done.
REINSTATEMENT OF LVRs RESIDENTIAL - High street banks such as ANZ and the Government have been putting pressure on the Reserve Bank to reinstate investor loan-to-value ratios (LVRs), and to look at increasing the minimum deposit to 40% for anyone speculating in the market or looking to buy a property that is not their primary residence. Yes, this includes that bach you’ve been thinking about, also any properties you are thinking of buying, doing up and flipping as well as any that you were thinking of renting out. (I cannot see how this will help the housing shortage.)
VERSUS COMMERCIAL - A 40% deposit is what is typically required to purchase a commercial property from most high street banks, depending on your relationship with them and your personal circumstances. So, in essence, it’s no different to purchasing residential.
RETURNS AND YIELDS RESIDENTIAL - As with anything, supply and demand is Economics 101. With the ongoing heat in the market driving up the prices of properties and a ceiling on what people can pay in rent due to wages increasing at a fraction of the rate, not to mention the Government’s changes to how often you are able to increase the rent, returns on residential investments are not what they used to be.
VERSUS COMMERCIAL - Due to the wide variety of commercial property out there, you are able to enter the market as low as $50,000 and as high as $50,000,000 (and anywhere in between), anywhere in the country, with returns/yields ranging between 7% to as high as 50% depending on what you buy and how good your commercial agent is with finding the right tenants for you. You can review the rent every year against the market, CPI or both. Your agent should always include a “ratchet clause” meaning the rent will only ever go up, never down. When buying, locations which offer significant growth, are central and offer excellent natural resources - particularly in the provinces - are always a great decision. Taupo is an excellent example of this. Centrally located in the North Island, Taupo is still seen as provincial New Zealand; it offers an excellent transport network and shows strong growth, with many companies seeing this as a future transport and business hub.
LEASE TERMS RESIDENTIAL - With new legislative changes coming into effect, the standard 12-month fixed-term tenancy will now automatically roll over to a periodic tenancy. The new RTA Amendment Bill also removed the 90-day termination, meaning that you are going to be sitting with a tenant on a month-by-month term and will need to go through the Tenancy Tribunal to remove them.
VERSUS COMMERCIAL - Generally speaking, a tenant would never sign for a period of anything less than three years and sometimes as long as 25 years, depending on the type of tenant and the property. The longer they sign, the better the WALT (Weighted Average Lease Term) and the more valuable your property becomes. No tribunal for commercial tenants!
COSTS OR OPEX RESIDENTIAL - With a residential tenancy, the landlord typically pays all the operating expenses (OPEX) of outgoings, such as, rates, insurance, GST, water, maintenance, and so on.
VERSUS COMMERCIAL - With commercial property, the tenant pays the rent plus GST and, more often than not, the OPEX. This covers everything over and above the rent that would otherwise be a cost to the landlord. The tenant is normally invoiced separately for this. Also, a smart agent will include a management clause in the Agreement to Lease (LTA), which allows for a management fee. This is paid to either the landlord or a property manager to manage the property.
TIME TO BUY COMMERCIAL - In summary, if you are looking at the interest you are getting on money in the bank (more often than not, it’s between 0.6% to 0.8% after tax and bank fees), and wondering what’s going on with the world, consider a commercial property to diversify your portfolio and earn 7%-plus. Make sure you build a relationship with a good commercial agent - they are worth their weight in gold (literally)! And, whatever you choose to do, sell high, buy low, talk to the man in the know!
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