Property investment: Residential vs Commercial

Mish Daniel says some of the key differences between residential and commercial property investments relate to tenants, leases and diversity of assets.

Mish is the founder of Revolve Commercial who has been investing in commercial property for over a decade.

On the Get Invested podcast with KnowHow’s Bushy Martin, she talked about the key changes residential property investors should expect when transitioning into commercial property.

Residential vs commercial property assets

Mish said investors need to analyse the pros and cons of different commercial property assets, such as retail, industrial or office. Although, the key deciding factor will be whether or not ‘the numbers stack up’.

“I do not like investing in properties in the sky. Even if it’s an apartment, I always say, why would you want to buy a hole in the sky? You’re reliant on lifts and services with very heavy strata, and that’s exactly the same in commercial offices that are higher than two to three floors. Now the other reason why we don’t like these properties is because they’re highly competitive. If you’re in an office, what do you have? You have a couple of desks and chairs and office furniture. If there’s a cheaper property three floors down and your tenant’s coming to the end and they’re looking around, they might come back and say, hang on, I’m paying 100K over here, when I could be paying 80K just two floors down. How easy it is for them to move down, and just like that you’ve lost your tenant,” Mish explained.

“We do however see a lot of opportunities with high yields in that sector because that is high risk. And what you definitely want to do, if you are going to buy one of those properties, is ensure you’ve got a good, long, solid lease and a client that’s been there for ten years plus and they’re happy to stay there and they’re not worried about their rental, then happy days. But always think of it in terms of longevity – if the tenant does move out in ten years, can you lease it? At what rate? And are you buying it today at a rate that you can sell it or lease it up in ten years time?

“On the other hand, the sweet arch in commercial right now is industrial. Everybody’s chasing industrial. Is it the right or best thing to buy right now? Well, horses for courses. If you’re going to be buying industrial at 5%, I’m going to say don’t do it. We chase the numbers, and if we’re finding industrials at around 6%, then happy days, we love them. If there’s nice long leases on it, if there’s longevity, if they’re good businesses, then go with them.

“We’ve also been incredibly successful in the retail sector. I really like this little retail sector because it overlaps two areas. You can have retail on the front, which can be office retail, with warehouse and distribution on the back. So it’s that mix of sectors of industrial, retail and office that we get into. But again, it doesn’t really matter what type you buy as long as the numbers stack up and the due diligence works and you’ve got exit strategies.”

Residential vs commercial property leases

While residential property often include six to twelve month leases, commercial property leases generally span between three to 20+ years, depending on the sector.

“You’ve got very long leases in comparison to a residential lease. In the retail sector, you’re looking at three to five years, while industrial is generally five to 10 years plus we’ve also seen leases go 20 to 30 years. And then you’ve got the office commercial, which is the third sector, which varies between the three to 10 or 20 years as well. So there’s your longevity and there’s your capital growth and market growth,” Mish said.

“Now there’s a bit of a myth with regards to market growth, because in residential people say, oh, I’m buying in an area that’s gentrifying, commercial you can’t get that. Well, I’ve got news for you – whatever happens in residential happens in commercial. In years gone by, there might be a 12 month delay, which was absolutely beautiful because what we would do in commercial is we’d go and have a look at what areas are gentrifying in residential, and we know wherever there’s people, there’s business. You need your butchers, bakers, barbers, hairdressers, dentists, medical centres. Wherever they are building there’s gentrification, and you need the commercial aspect. So as the rate and the value of your residential properties are increasing, so is your commercial.

“However, you have market growth and you’ve got capital growth in commercial. And the beauty is in commercial, your capital growth is what value you’re adding to that building and your incremental increases, which is generally CPI or 4%. So for example we’ve just signed a lease with a 7% incremental increase. So you might be asking why? The rental was quite average, deflated. So the tenant that came in said, look, I want to stay here for a long time, I’m prepared to sign a five year lease, but give it to me at a low rental now, and I’ll sign a seven year incremental increase. What does that mean per year? We ran the maths, and that is exceptional growth over that period. And you cannot match it with market growth.”

Residential vs commercial property tenants

Mish explained that tenants and vacancy rates pose a greater risk in commercial property compared to residential, especially if investors fail to do their due diligence.

“If you’re not doing the correct due diligence, this is where you’re going to get caught with your pants down. You’ve got to make sure that the asset is 100% fail safe and that you’re looking into all of these different areas and options. Whereas in residential, you don’t really need to do that. You’ve got a building, you’ve got tenants, you’ve got people that need a place to live,” she said.

“In regards to vacancy, one of the reports that we do automatically is a vacancy report. So, we’ll do the vacancy rate of that area, of that type of business, and that type of asset. What we also do is a commercial market analysis to see how long that property has been vacant, if there are other vacancies, how long they’ve been vacant for. So there are a lot of reports in the background that you can do.”

Listen to the full interview here.

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