Is commercial property a good investment when compared to residential?

The commercial property sector is enjoying a period of prosperity on the back of a strong New Zealand economy. What's more, commercial property yields have remained roughly 1.5 percentage points higher than interest rates, offering attractive and easily accessible opportunities for investors. 

Considering the recent strength of the sector now may be a good time for residential investors to dip their toes into the commercial market. With that in mind, let's consider: Is commercial property a good investment when compared to residential?

Commercial property can be a fantastic investment.

What are the positives of investing in commercial property?

Higher rental yields: Generally speaking, commercial property promises better returns than residential. In fact, total returns for commercial property were as high as 10.4%, on average in early 2017, according to Morgan Stanley Capital International indexes. 

The gross rental yields of residential real estate in New Zealand, on the other hand, vary widely. In Auckland you'd be lucky to find a rental yield of 4%, while further south in Dunedin you may able to find a property returning 8%. This is one of the more compelling reasons to explore a commercial property investment.

Less outgoings: When you own a residential investment property you're responsible for costs such as rates, insurance, maintenance and perhaps body corporate fees. Commercial tenants on the other hand will usually cover all of these costs, and may even make improvements to your property, increasing its value. This reduces the cost of running your investment and helps keep your money safe in the bank.

Longer leases and more reliable tenants: If you own a residential investment your tenant will most likely be a family or a group of friends. Your lease may be for a term of a year or six months, and rental increase will not be included in the agreement. 

With commercial property you'll have a business as your tenant. Your lease will generally be of a term between two to 20 years, with rent increases written in at agreed upon amounts throughout the lease. With a long term lease in place your income will be guaranteed, and your property's value may increase as the rent does.

If you buy smartly you can minimise the risks of investing in commercial property.

What are the drawbacks of commercial property?

Higher risk of vacancy: When comparing commercial property to residential, vacancies are an important talking point. As a general rule commercial property has a higher risk of vacancy than residential properties do. That's because most commercial properties are often suitable for specific types or sizes of businesses, whereas residential properties often suit a larger range of people.

When your residential investment becomes vacant you may have hundreds of house hunters show interest, whereas with commercial property you may only find a few interested parties. For that reason vacancies can be more difficult to fill with commercial, which may be a problem if you need rental income to cover your mortgage repayments.

Sensitivity to changes in the economy: When New Zealand's economy is strong the commercial property market usually follows suit. However, when the economy dips and businesses are struggling, the demand for commercial property could drop off. 

This could increase the risk of vacancies and reduce the value of your property and its market rent. On the other hand, everyone needs a roof over their heads so residential property is less susceptible to the economy's ups and downs. 

Property's value tied to strength of the lease: If the leasing market is strong and you've got an attractive tenant in your property with favourable lease terms, your property's value will increase. Conversely, if you have to compromise on lease terms, and perhaps charge less rent to fill a vacancy, your property's value could quickly plummet.

This means the value of your property is tied to the quality of your lease, and a vacancy during a weak leasing market could hurt the value of your investment. 

Despite the risks, commercial property can be a great investment if you buy well and do your homework. Start your search for property and insider information by accessing New Zealand's biggest online property listing platform: realestate.co.nz.