Recently we have seen more and more enquiry from residential investors looking to get into the commercial investment market. Many of these investors are “mum and dad” investors that have anything from 1 to multiple residential properties in their portfolio.
Many of these investors are “mum and dad” investors that have anything from 1 to multiple residential properties in their portfolio. A common tale is that they are becoming disillusioned with residential property investment and that with the increase in house prices coupled with conservative rental growth and government announcements, residential property investment is not producing the returns they used to and will not sustain investors in retirement.
A good example of this was an article that was in the Manawatu Standard recently, which had one commentator predicting, at the current weekly rate of house price increases, that the median house price could reach $1 million by the end of 2021. With the median rent for a three-bedroom house in Palmerston North being $468 pw (Tenancy Services Market Rent report), this equates to a 2.4% return.
With Commercial property being able to produce a 5-7% return in many towns, along with other benefits of Commercial property ownership, no wonder Commercial property investment is looking more and more attractive to residential investors.
So what are the key differences between investing in residential and commercial?
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.
CHANGE IN TAX DEDUCTIBILITY RULES - Recently announced changes to tax deductibility rules mean that owners of a residential investment property will no longer be able to claim the interest portion of their mortgage payments as a tax deductible expense.
VERSUS COMMERCIAL - These new rules don't apply to commercial investment properties such as shops, offices, warehouses and factories meaning owners will still be able to claim mortgage interest as a tax deductible expense.
HEALTHY HOMES STANDARDS - 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 ensuring a minimum indoor temperature of 18˚C, placing range hoods over the oven, ensuring extraction in the bathrooms and more. Not to even mention the controversial tenancy law reforms resulting in a number of changes to the Residential Tenancies Act 1986.
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 LVR - High street banks and the Government have put pressure on the Reserve bank to reinstate the LVR, and increase deposits to 40% for anyone speculating in the market or looking to buy a property that is not their primary residence.
VERSUS COMMERCIAL - 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, its no different to purchasing residential.
RETURNS AND YIELDS - 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 5% 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.
LEASE TERMS - 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 removes the 90-day termination, meaning that you are going to be sitting with a tenant on a monthby-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 OF OPEX - With a residential tenancy, the landlord typically pays all the cost (OPEX) of outgoings, such as rates, insurance, GST, water, maintenance etc.
VERSUS COMMERCIAL - With Commercial property, the tenant pays the rent plus GST and more often than not, the OPEX (OPerating EXpenses). 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 LTA (Agreement To Lease) which allows for a management fee. This is paid to either the landlord or a property manager to manage the property.
When you weigh up the pro's and con's of each of these types of investment, it is easy to see why more and more residential investors are looking at commercial investment as a viable option.
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