Investing in commercial property has a number of advantages over investing in residential property. One of the main advantages is the lease terms. Commercial leases tend to be for longer terms. So, with residential property you might get a 6-month or a 12-month lease, but commercial properties can have 3- to 5-year leases, and even longer.
For a commercial tenant this is linked to the security of his business. If he has to relocate he cannot be sure his customers will follow him to the new location, so commercial tenants tend to remain longer than residential tenants.
For investors this can mean that even for a small commercial investment property, the income is secure for a longer period.
Rents paid by commercial tenants are also generally secured by a bank guarantee that stays current even if the tenant relocates and sub-lets his premises.
Another advantage of investing in commercial property is that growth is generally more certain because rent reviews are written into the lease. In many cases there is also a provision that when the rent is reviewed, it cannot be less than the rent for the previous year. This is very unusual in residential leases, whereas it is the norm in leases for commercial property.
With commercial property the expenses of operating the property, such as air conditioning, fire protection and security, are generally paid by the tenant. When increases in these costs occur they are also paid by the commercial tenant. This is quite different to residential property, where it is the landlord that pays. Where these costs increase and the landlord cannot pass them on, this effectively decreases the landlord’s profit margin.
When buying a commercial property you can usually get a loan up to 70-75 percent of the value of the property. When assessing your loan application, the lender places greater emphasis on the strength of the tenant and the security of the cash flow from the tenant’s business than on your own personal financial circumstances. This is a major advantage when you go to buy commercial property because your wealth creation is not tied to your own personal financial situation to the same degree as it is with residential property investment.
If the rent is not being paid, the remedies available to a commercial property landlord are much more in the landlord’s favor than the remedies available to a residential property landlord. For example, in certain circumstances non-paying commercial tenants can actually be locked out and their possessions sold to recover the debt. You would not normally find this with residential investment property!
Compared with some other forms of investment, such as artwork, gold, antiques, etc., investing in commercial property provides investors with both income and capital growth - in the same way as residential property. Historically, property has also provided higher long term returns than bonds and cash. In addition, there are significant tax benefits for commercial property investors - for example, depreciation allowances on building plant and equipment, such as air conditioning and security, and the structure of the building itself.
As with residential investment property it is possible to borrow against your commercial investment property. You can use this leverage to build a commercial property portfolio - if this fits within your investment plan.
Property is also a tangible asset – it is physical, unlike bonds and company shares. So with direct property investment you have a significant degree of control. This is not the case if you are an owner of shares, or listed or unlisted property entities, where you have little or no direct control over how your investment performs, as effective control is vested in the management agreement.
Rarely are the values of direct property investment subject to sharp and spectacular declines, such as can be the case with shares, or where properties form an asset of a collective ownership, such as company trusts, etc. The control is then vested in the board/management which has the power to pledge the assets as security to gain further properties or other investments not necessarily compatible with property. When this leads to financial over-commitment, it is the level and/or terms of borrowings, not the quality or performance of the property itself, that is the cause of the problem.
Another advantage of investing in commercial property is that you can add value to it. You can renovate, upgrade, subdivide, get development approval or change the use. There are more opportunities to add value to commercial property than there are to add value to residential property.
General investment advice is that you should not have all your eggs in one basket and should smooth out your investment returns, or reduce your investment risk, by having a spread of investments. This is another good reason to include commercial property in your investment portfolio. More advice on investing in commercial property to come.
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