Is investing in commercial property better than residential?
Looking at your property investment options in a (mostly) post-COVID-19 economy probably has you wondering whether commercial or residential property investment is better. There are similarities and differences between investing in residential or commercial property — understanding more about their pros and cons may help guide your investment decision.
Below, we look at the differences in commercial vs residential property investment and discuss how NDIS property investment could offer your portfolio the same financial benefits but with more outstanding social outcomes.
Commercial vs residential property investment
Generally, when looking at the differences between commercial and residential properties, investors want to know whether one is a standout in terms of financial performance — but it’s not always that straightforward.
Some of the differentiating factors include:
Commercial property investors often favour commercial real estate, as historically, it has shown to have higher income yields than residential property. Over average residential rental yields of 3% to 4% gross pa (meaning you still need to pay tax and other expenses), commercial properties returned in the vicinity of 5% to 10% net (which is after taxes and expenses!). However, the inflated residential rental market could be shortening that variance.
Due to existing in different markets, the capital growth potential between a residential and commercial property also differs. While most investors look to commercial property investment as a means to access passive rental income, there is still notable capital appreciation that can be achieved over the life of the investment. Many Aussies are familiar with the capital growth potential of residential property, as they’re experienced in witnessing the buying and selling of homes over the long term.
Residential and commercial properties also have some contrasts in variability. For example, commercial properties tend to have more significant variables, such as the length of the lease. Commercial leases typically have most of their conditions open to negotiation, whereas residential leases have far less negotiable terms. This means that most commercial leases need to be written under the guidance of financial advisors and lawyers.
Some economic trends and the overall economic outlook can significantly impact the commercial market over the residential market. COVID-19, for example, has disrupted market cycles across almost all asset classes. With a large number of Australian businesses being unable to trade, it seriously impacted the commercial property market. However, the large-scale relocation that the pandemic incited means that commercial property in growth areas such as the Sunshine Coast and Gold Coast in Queensland and Perth in Western Australia benefit from the spike in population growth.
Tenant behaviour & Vacancy
Residential tenants and commercial tenants understandably behave differently. In a residential property, it is the tenant’s living quarters, whereas commercial tenants are typically running a business. Due to the commercial property being necessary to derive income for commercial tenants, there is often more incentive for the tenants to keep the property in excellent condition and address maintenance or repairs as a matter of priority.
Vacancy risk also varies between the two types of property. As of September 2022, the vacancy rate in the residential property market was under 1%! Whilst good news for residential property owners, the commercial market experienced vacancy rates of around 10%. Extended vacancy periods are not uncommon in the commercial market, as finding a suitable commercial tenant can be more challenging than securing a residential tenant — especially in the current rental climate.
Before reaping the financial rewards of residential or commercial property investing, investors need to be able to finance the purchase. Property costs are often vastly different. Real estate investing offers property types of all size and scale, meaning that residential investment is often within reach for more investors. Also, financial institutions will generally lend more of the property value for residential properties over commercial properties. What this means for investors is that the loan-to-value ratio (LVR) on commercial loans is much lower, resulting in banks generally requiring a much higher deposit amount for a commercial loan.
Commercial investors also need to be aware that lending criteria to finance commercial investment can be tighter, as in some cases, it is deemed higher risk. The risk is then generally offset by the higher rental yields achievable over residential investment.
NDIS property investment as an alternative to buying residential properties or commercial properties
The introduction of the National Disability Insurance Scheme (NDIS) brought with it the Specialist Disability Accommodation (SDA) program. SDA is a range of housing that is purpose-built to provide suitable housing to support Australians with extreme functional impairment or very high support needs.
To encourage both social and economic participation, the federal government opened the SDA market to private investors, incentivising the program for investors through funding of up to $700 million each year.
Being such a specialised form of housing means that SDA offers investors the opportunity to access property investment that is largely uncorrelated to either commercial or residential real estate and access a market that provides a benevolent outcome for members of the Australian community living with disability.
Here’s what you can expect from investing in an SDA property over commercial and residential property:
Income yield and capital growth
The average rental yield of an SDA property can be upwards of 10-20% pa, rivalling the best-performing commercial properties in Australia. Due to the high demand and ongoing need for specialist disability accommodation, there may also be fantastic capital growth opportunity within the SDA market.
Investing in the NDIS sector means that there are very stringent conditions and requirements for SDA investing. These are clearly outlined with the SDA rules and NDIS guidelines, meaning there is very little room for negotiation, providing clarity and transparency over your projected financial outcome and lease terms for each tenant.
Tenant behaviour & vacancy
The tenants residing in SDA homes have all been approved under the NDIS and experience extreme functional impairment or high support needs. It is common for multiple tenants to live together in one SDA home. NDIS support workers and allied health professionals assist within the home.
Thanks to the level of support and independence that SDA properties provide, they often become ‘forever homes’ for the NDIS participants that reside in them — meaning that tenant-turnover is usually much lower than residential property tenants. The high demand for SDA homes can also translate into low vacancy risk. The SDA provider or specialist SDA property manager you engage to help manage the home manages any vacancies on your behalf.
Financing your NDIS investment property is more similar to residential property investing but comes with additional requirements. Our team at Apollo Investment include NDIS industry professionals and financing professionals to ensure that you can access the best lending strategy for your SDA property purchase.
Our end-to-end solution also means accessing architecturally designed properties to stand out from the array of cookie-cutter designs on the market and provide the best opportunity for tenancy and capital growth potential.
To find out more about how adding an SDA dwelling to your property portfolio can lift your portfolio return and the quality of life for an Australian living with disability, book a call with our team.