For many investors, residential property investment is an easier choice, because it is more familiar and approachable. Investing in residential property is similar to purchasing a home, however, commercial property investment can be far more daunting. For those who are willing to learn, commercial property can prove a better investment for certain investor profiles, but it’s important to understand the differences between each type of investment.
Different initial costs for residential and commercial need to be considered, as well as differences in cash flow and ownership, stability and tenancy turnover, and both rental and capital growth, which can determine whether you should invest in residential or commercial property.
We’ll be exploring the upfront costs associated with residential and commercial property, expenses, and other key information that you need to know when planning your next investment, whether you’re a first-time buyer or a seasoned investor.
What Are The Initial Costs Of Residential & Commercial Property?
Residential
When buying a residential investment property, your initial purchase costs include:
- Your initial deposit (usually 10-20% of the purchase price)
- Stamp Duty (find out your estimated stamp duty rate here)
- Transfer Fees
- Mortgage Registration
- Brokerage Fees
- Solicitor Fees (approx. $2,000)
- Buyer’s Agency Fees (usually approx.2% of the purchase price)
- Building / Pest Inspection (usually approx. $800)
As an example, when buying a residential investment apartment for $2 million dollars an investor, your initial outlay would look something like this:
| Deposit @ 20% | $400,000 |
| Stamp Duty | $94,200 |
| Transfer Fees | $155 |
| Mortgage Registration | $154 |
| Brokerage Fees | $800 |
| Solicitor Fees | $2,000 |
| Building / Pest Inspection | $800 |
| Buyer’s Agency Fees | $40,000 |
| Total Cash Investment | $538,109 |
Commerical
When buying commercial property, the initial outlay is higher than buying a residential property of the same price, but the higher initial outlay typically comes with immediate benefits, including higher cash flow.
When buying a commercial investment property, your initial purchase costs include:
- Your initial deposit (usually 30-40% of the purchase price)
- Stamp Duty (find out your estimated stamp duty rate here)
- Transfer Fees
- Mortgage Registration
- Loan Establishment Fee (0.15-0.5% of the total debt)
- Valuation (approx. $3,500)
- Solicitor Fees (approx. $2,000)
- Buyer’s Agency Fees (usually approx.2% of the purchase price)
- Building / Pest Inspection (usually approx. $800)
A $2 million commercial property may look more like this:
| Deposit @ 40% | $600,000 |
| Stamp Duty | $94,200 |
| Transfer Fees | $155 |
| Mortgage Registration | $154 |
| Loan Establishment Fee | $7,000 |
| Solicitor Fees | $2,000 |
| Valuation | $3,500 |
| Building / Pest Inspection | $800 |
| Buyer’s Agency Fees | $40,000 |
| Total Cash Investment | $747,809 |
Cash Flow & Ownership Costs
Residential
The typical residential investment property has a 3-4% gross yield.
To carry on our example, you could expect a rental return of between $1,200-$1,500 per week ($62,400-$78,000 per annum) in metropolitan Sydney on an investment property of $2,000,000.
Property owners pay the outgoing expenses for residential investment properties and are also responsible for the ongoing maintenance of the property. Property owners should budget around 2 months of rental income per year to cover incidental and routine maintenance expenses.
For a $2,000,000 residential investment property in Sydney, the net yield would sit between 2.7% and 3.5%, and monthly finances could look something like this:
| Mortgage Repayments | $7,185 |
| Monthly Outgoing Expenses | $667 |
| Management Fees | $410 |
| Budgeted Maintenance Costs | $1,000 |
| Total Monthly Expenses | $9,261 |
| Rent Collected + | $5,850 |
| Monthly Cashflow Position | -$3,411 |
Commercial
The typical commercial investment property has a 4-6% gross yield.
On a retail shop example for the same price in a similar location, you could expect a rental return of around $1,923 per week, or $100,000 per annum.
As tenants pay the property’s outgoing expenses and cover all non-structural maintenance, the net yield on a commercial property is higher. For a $2,000,000 commercial asset in a Sydney metro location, the net yield would be 4-5%.
However, incentives such as rent-free periods or capital contributions are typical features of commercial leases. For example, it’s usual for there to be a 1-month rent-free period per year built into a commercial lease.
The monthly financial position would look something like this:
| Mortgage Repayments | $6,287 |
| Monthly Outgoing Expenses | $0 |
| Management Fees | $416 |
| Estimated Maintenance Costs | $0 |
| 1-Month Rent-Free Incentive | $694 |
| Total Monthly Expenses | $7,397 |
| Rent Collected + | $8,333 |
| Monthly Cashflow Position | +$936 |
Whilst the initial outlay for commercial property is higher, investors have an immediate positive cash-flow position.
Stability & Tenancy Turnover
Residential
The typical term for a residential tenancy agreement is just 12 months.
Each time a tenant vacates, the property needs to be advertised and re-let to new tenants.
This reletting process typically costs the landlord the equivalent of 1-2 weeks’ rent in letting fees, plus an additional $500-600 for online advertising and signboard costs. Once advertised, a typical residential investment takes 1-4 weeks to tenant.
If the property is unfurnished, this high tenancy turnover significantly increases the likelihood and severity of wear and tear. There may also be maintenance costs and a brief period of vacancy that the property owner may need to absorb.
Commercial
Leases for a commercial property are usually between 3-5 years, with options for the tenant to continue for another 3-5 years once the initial lease expires, which is a key benefit of commercial property investment. Tenancy turnover for commercial property is infrequent, but the process of re-letting is much more involved and expensive than for residential properties.
Re-letting a commercial property may take 1-3 months and cost the landlord 11-12% of the annual rent in leasing fees. During the vacancy period, the owner will also have to absorb the property’s ongoing costs. However, there is usually no maintenance involved in-between tenancies.
Rental Growth & Capital Growth
Rental Growth
Another major difference between residential and commercial property is the way rental increases are managed.
For residential property, rents increase (or decrease) only when the market shifts. The typical rate of rental growth for residential property in Sydney is approximately 5% per annum.
For commercial property, market shifts play a role, but rental increases are typically pre-planned and built into the leases, with most commercial leases increasing on a schedule. For example, a lease might define a built-in annual increase of 3.5-4%.
At the end of the fixed commercial lease-term, there is usually a market-rent-review that takes place before the tenant exercises their “option” to stay for an additional period.
Capital Growth
Both residential and commercial investments are best used as long-game investments. No matter which asset class you are investing in, you should be prepared to buy and wait.
Residential investment properties, if bought well, offer strong capital growth to investors. It is normal for a well-located property in Sydney to grow in value by 50% or more over 10 years.
Commercial properties vary significantly in growth prospects. Office spaces and retail shops grow at vastly different rates, so it is difficult to speak broadly for all commercial properties, but on a $2,000,000 Sydney retail shop example, you can expect 10-year growth of around 40%, which occurs in line with annual rental increases.
Both residential and commercial asset classes make fantastic investments, offering investors financial stability, healthy capital growth and a hedge against inflation.
Residential properties require less up-front capital than commercial properties of the same price, with shorter leases and higher tenancy turnover, and landlords need to factor in ongoing expenses and maintenance costs. However, re-letting is cheap and quick, and vacancy is minimal.
Commercial properties on the other hand require more capital upfront but offer an immediate positive cashflow position and a higher rate of return for investors. They also have lower ongoing maintenance costs, most of which are covered by the tenant. The leases are longer and have in-built rental increases, but they are more complex and onerous as vacancy periods are longer, and leasing costs are higher.
When considering whether to invest in residential or commercial property, there are great arguments for both asset classes as investment choices. When building a property portfolio for wealth creation, it is best to diversify investments into both commercial and residential property.
If you have any questions about commercial property investment or would like to discuss which is best for you, get in touch with the Rose and Jones team now.
About Rose & Jones
Rose & Jones has been helping clients find and purchase properties in Sydney, Gold Coast and the Northern Rivers since 1998. A renowned property buyers agency across residential, commercial and industrial sectors, every one of our property experts meets our high standards, so you won’t have to compromise yours. With access to a wide network of off-market properties, our team can help you find the perfect property. Also offering property management services and investment advice, make Rose & Jones your go-to when it comes to real estate in New South Wales and Queensland.
