A question regularly asked by potential property investors is, “Should I put my money into commercial or residential property?”
Firstly, both types of property have the big advantage of being gearable.
This means that the investor who already has a good income stream can usually borrow a high percentage of the property’s price from a bank.
This is property’s main advantage in relation to other asset classes - the fact that it can be purchased with borrowed money.
From there on, the differences between residential and commercial property are fairly wide.
Generally, residential property makes the better choice for the less experienced investor, particularly if you have limited financial or property experience.
Buying and Selling
Residential property, especially in the current South African market, is easily tradable and/or rentable.
Buyers and tenants are fairly thick on the ground – and, if the property is rented, tenants are easily replaced.
By contrast, industrial, retail or office space presents the buyer with a more complicated set of problems.
Tenants are likely to be more difficult to find because tenants will choose commercial property that matches their particular business needs.
Retail and industrial space in particular tends to require a specific type of tenant following a specific line of business.
Return on Investment
In contrast to residential property, commercial property will generally give a better return (a Capex rate of ± 11% in South Africa at the moment compared to residential property where the initial returns are likely to be between 5 and 8%).
But, again, residential property is far easier to trade if your investment doesn’t fare well, whereas commercial property is more expensive and more difficult to shift.
The economic climate should also be considered when choosing to invest in commercial property. There is a risk of having to offer lower rental rates or risk your premises standing vacant if tenants have to downgrade owing to economic constraints.
While this is equally possible if you own residential property, it is less likely as residential rentals are in regular (and much higher) demand.
Investment Period
For shorter term investments, residential property is usually a safe bet because there is consistent demand (especially in growing metros) for residential and rental properties.
Buying a property in a new plot-and-plan development and flipping it for profit, or renovating a property in a gentrifying area and selling it after six months is also an option where residential property is concerned.
With commercial property however, short-term investments are those held for five years or less, and it is generally accepted that realising the income potential from a commercial property is a longer-term commitment.
Investment Amount
While purchasing any property demands a fair amount of capital, barriers to entry into the residential property market are lower than the commercial market.
Firstly, banks are far more likely to grant larger percentage mortgage loans for the purchase of residential property (up to 100%), while the associated transfer and ancillary costs are lower.
Secondly, because the value of commercial properties is much higher than residential property, and because of the nature of letting commercial property to tenants, the initial costs required for a commercial property investment are significantly higher.
Running Costs
Commercial property investments not only require a large capital outlay and sufficient capital to meet monthly bond repayments, but to cover additional expenses such as refurbishing parts of the premises for new clients, covering the necessary rates and taxes and other expenses, as well as making provision for upgrades and necessary building maintenance.
While residential properties incur a similar set of costs, these amounts are generally far lower and therefore more manageable for a first-time investor.
The Bottom Line
Making the decision between investing in residential or commercial property requires careful consideration, and a clear idea of your investment goals, and investment capacity.
Generally speaking, for the new or first-time investor it is wiser to begin with residential property and graduate to commercial once having gained some experience.
The risks and rewards of either property type can be great, but the fact remains that there is no better investment for the man-in-the-street than property.
