Choosing between residential and commercial.
Which path to choose?
Commercial properties are attractive because they do offer higher rental yields. However, since they are seen as a higher risk to lenders, you won’t get as large a loan. Plus, you run the risk of having longer vacancies than you would with residential properties. That’s why residential properties make for better investments because there will always be a demand for housing. If we look back to the discussion about population growth in Australia, residential property is certain to remain a hot commodity.
What is also important to note is the significant changes seen in the commercial property landscape following the COVID-19 pandemic. The pandemic forced businesses to embrace technologies that allowed employees to work from home. In addition, it has also increased confidence in online shopping by an exponential factor. In August 2021 ABS data reported that online sales in Australia had increased by 114% in the year to date compared to the same period in 2019.
As a result, different types of commercial real estate have experienced dramatic declines in demand while others have dramatically increased. For example, demand for commercial office space has declined as many big companies are not renewing their leases in favour of hot-desking and work-from-home setups. Many larger companies are going for smaller office spaces that allow their employees to work remotely the majority of the time and bringing them in maybe once a week on a rotating roster where they make use of the hot desks.
Additionally, demand for retail shops has also declined as many new retail brands are going 100% online. I mean, why wouldn’t you? Why have a shop in the local shopping centre where you can only sell to people who physically walk past your shop when you can have an online store that sells to the entire world? With the decline in demand for retail space, we’ve seen an increase in demand for warehouses and distribution centres, cutting the retail storefront out of the supply chain entirely. The supply chain now looks a little different: from manufacturer to distribution centre and then directly to the consumer’s home.
If you pay attention to the industrial areas around where you live, you’ll notice that big warehouses are becoming more of the norm as areas develop. Those warehouses are full of amazing robotics, conveyor belts and barcode scanning technologies that can handle materials and dispatch them with almost complete automation. So, if you are looking to invest in commercial property, you should rather look at warehousing and distribution centres rather than retail shops and office space. But if you refer back to LVRs, you’ll probably want to avoid commercial property anyway.
Which is the right financial choice? Houses, townhouses or apartments?
The best cash flow is usually found in houses since they don’t have body corporate fees. Body corporate fees tend to wipe out your cash flow. Since houses are stand-alone and you are the sole owner, there’s no need for body corporates and additional fees. On the other hand, townhouses and apartments share common grounds that need to be maintained collectively by all the owners. These include all facilities that you share with your neighbours including driveways, gardens, elevators, gymnasiums, swimming pools and so on.
Additionally, with a house, you avoid all the friction that comes with being involved with a body corporate. It’s not just about the money, but also your time and stress. Body corporate situations with townhouses and apartments can often involve a lot of conflict between different owners and landlords. Topics of contention often include whether or not to paint or upgrade the pool. There are generally two parties in these situations: the investors who are tight with their money and don’t want to spend money on making improvements, and the owner-occupiers who live in the complex wanting to spend the money. The latter are usually retirees who have the spare time to be on the committee and are there day-to-day and want the place looking the best it possibly can.Houses also tend to perform better from a capital growth perspective because they have a greater ratio of land compared to the actual structural dwelling. Theoretically, the structure is going down in value as it depreciates but the land is going up in value. When you have a townhouse, you have a slightly smaller portion of land to structure. For an apartment, that ratio becomes even smaller.
I often refer to apartments as concrete boxes in the sky. If you compare a tower of 300 apartments to the land it sits on, you have a very small 1/300th share of land. That might only be 10 metres or not even that much in some cases.
I have recommended townhouses and apartments in the past. When the price point to buy into that particular area was too much to buy a house. It might be an acceptable compromise to get a cheaper townhouse or apartment. But this should normally be avoided for the reasons mentioned above.
I’m not saying that you should never buy a townhouse or an apartment. I’m just saying that you need to be aware that cash flow won’t be as good and there may be some friction with the body corporate.
Defining your property strategy: High, middle or low end of the market?
When discussing the strategy of avoiding problematic tenants, selecting a property in the middle of the market is the best route to take. Here’s why:
High-End Market:
At the high end, trophy properties like mansions and canal homes can yield substantial capital growth in prosperous times. However, during economic downturns, their value plummets as financially stressed individuals offload non-essential assets. High-end properties suffer significantly in terms of value, while the middle of the market remains stable. Rental yields at the high end are low due to wealthy tenants who often prefer to buy. Moreover, the low demand for high-end rentals results in diminished rental yields, making positive cash flow difficult to achieve.
Low-End Market:
In the low-end market, high rental yields exist due to residents living paycheck to paycheck, leading to intense competition for rentals. However, capital growth is limited as the area becomes more run-down. Older properties in this segment often incur high maintenance costs and tenant problems, compromising overall profitability. Investing in ‘cheapies’ for high rental yields may lead to losses due to maintenance issues and troublesome tenants.
Middle of the Market:
The optimal choice lies in the middle of the market, exemplified by a four-bedroom, two-bathroom, double-garage family home. This segment offers respectable rental yields, covering property costs, especially with brand-new properties that require minimal maintenance. Additionally, securing reliable tenants is more probable in this market segment.
Hope you are getting value from this series and enjoying all the property insights I have learnt over the years. Come back for my explanation on the bell-shaped curve of housing demand!
~Daimien Patterson