Comparing your investment options
July 22, 2015 in Investing
Choosing which type of property to invest in depends on your available capital, your risk appetite and your income and cash flow requirements.
Types of property
The four main market segments are industrial, retail, office (these are all commercial properties) and residential.
Industrial properties include distribution, manufacturing or warehouse facilities. There are three main categories:
- Warehousing and distribution space is used for storing, distributing and transporting products between destinations. A typical tenant might be a wine or furniture importer, with limited office requirements.
- Office/warehouse space has a mix of office and industrial space, with a larger portion of office space than standard warehouse. It is often located with similar buildings in industrial parks. Tenants can be of any type as most industrially-oriented businesses will have an administrative component associated with their warehousing.
- Manufacturing space ranges from simple space in flex parks to highly customised space for heavy industrial use by large manufacturers.
Retail space can be found in a number of different types of centres. Centres are classified as follows:
- Strip centres: Individual shops on the street front
- Homemaker or bulky good centres: Less than 5,000 square metres with specialty shops displaying merchandise
- Neighbourhood centres: Less than 10,000 square metres and with one or two major supermarkets
- Sub-regional centres: Around 20,000 square metres and with at least one major discount department store and one or two supermarkets
- Larger shopping centres: Classified as regional, major regional or super regional depending on their size.
Offices are classified according to grade and location.
- A-grade space (prime office space) is often brand new or has had a full refurbishment. It has state-of-the-art facilities and furnishings, excellent accessibility and appeal to high-end tenants who can pay top dollar.
- B-grade space (secondary space), which is the common rental space tenanted by businesses, is well maintained with adequate facilities and accessibility, and commands average rental rates.
- C-grade space, usually in older buildings, includes functional spaces for tenants looking to pay cheap rent. Furnishings and facilities are minimal, accessibility may be difficult and maintenance unreliable.
- Offices are classified as CBD office or suburban office.
If you’re purchasing more than 2,000 square metres of space you’ll need to obtain a Building Energy Efficiency Certificate (BEEC). This is a report on the building’s energy efficiency and it has two parts. Part one is a National Australian Build Environment Rating System (NABERS) Energy for Offices rating, which assesses the building’s overall energy efficiency. Part two is a CBA tenancy lighting assessment (TLA), which measures the general lighting system’s power density. This report, and in particular the NABERS rating, will have a strong influence on the building’s grade and value.
Types of residential properties include:
- Freestanding houses.
- Holiday homes (which can be any of the above).
There are important differences between investing in a commercial property and investing in a residential property. The markets differ in terms of potential yield, capital gain, cash flow potential, price points and risk. There are advantages and disadvantages to each type of investment, so it depends on what you can afford and what you want to achieve.
- Yield: Yield is typically higher on commercial properties – retail usually yields around 6 per cent, office around 7 per cent and industrial around 8 per cent, although this varies with the location, the quality of the building and current market fundamentals.
- Income stream: Commercial tenants pay more rent than residential tenants, so income is higher.
- Cash flow: Since tenants pay for rates, insurance, repairs and maintenance, fit-outs and property management fees, your cash flow is greater.
- Return: Return is mostly in the form of ongoing income that can be accessed immediately.
- Lease: Longer leases (up to 10 years), with options to renew and rate increases built into the agreement, give landlords greater income stability and reduce the risk of vacancy.
- Time: Minimal ongoing investment of time and money is required due to the length of the lease.
- Tenants: Problematic tenants are less common.
- Price point: Prices are typically higher: a small retail or office suite in the suburbs might sell for around $500,000; however, most good quality office premises sell for over $1 million, with quality industrial premises usually over $2 million.
- Risk: Risk is higher due to the possibility of long vacancies – particularly in unfavourable market conditions – and the fact you have more money at stake.
- Capital growth: Potential for capital gain is lower, since land appreciates but buildings depreciate and the building usually takes up most of the value on commercial properties.
- Deposit: A larger deposit is required as borrowing capacity is usually 30 to 50 per cent of the property’s value. This is because the lower capital growth potential makes it harder to cover the interest paid on the loan.
- Liquidity: Commercial property is not a very liquid asset – it is generally harder to sell as there are fewer buyers.
- Capital growth: Potential for growth is better, since land makes up most of the property’s value and there is a more consistent demand for housing.
- Entry point: Prices are lower – you can find small apartments in regional areas for around $100,000, although a quality two-bedroom unit in Sydney will be over $500,000.
- Risk: Risk is lower, as long-term vacancies are highly unusual and less money is at stake.
- Deposit: You can borrow a high proportion of the property value as long as you can service the loan, as capital growth often offsets the interest on your loan.
- Liquidity: It’s usually easy to sell a residential property fairly quickly, as people will always need a place to live.
- Income stream: Residential tenants can’t pay as much rent as businesses, and rental returns are often no more than loan expenses, so ongoing income may be minimal.
- Cash flow: Landlords must pay rates, insurance, repairs, maintenance and property management fees themselves, which dilutes cash flow.
- Yield: Yields are typically lower.
- Time: The chance of ongoing investment of time and money is greater, since leases are short (six to 12 months) and tenants are more likely to make demands.
- Return: Much of your return is in the form of capital gain, which can’t be accessed until the property is sold.
Comparison within the residential sector
While residential properties all adhere to the same market fundamentals, each subsector has its own unique characteristics.
- Price: Units generally cost less, offering a smaller financial commitment.
- Expenses: Houses incur higher council rates whereas units incur strata fees and special levies. You pay all maintenance on a house, whereas unit maintenance is shared between building owners.
- Investment aims: If you want to renovate and sell, a house gives you more flexibility and more potential for short-term capital growth.
- Yields: Units usually offer higher yields – around 4.5–5 per cent, compared to 3.5–4 per cent for houses.
- Expenses: Around 45 per cent of rental income can be eaten up in expenses including cleaning, utilities, advertising and booking fees, insurance, extra maintenance and repairs (due to higher wear and tear).
- Common pitfalls: Pitfalls include potential council regulations around holiday rentals, existing contracts for management of the property with high commissions, being lured by the idea of a holiday retreat and not researching market fundamentals.
- Time: A lot of time and effort is required to manage bookings yourself.
- Yield: Yield is around 3.5 per cent to 4.5 per cent for properties under $2 million, and around 3 per cent for high-end properties.
- Bonus: Owners have the flexibility of having access to their own holiday home.
- Tax benefits: You can claim a higher depreciation rate (4 per cent for 25 years) for short stay homes, improving your tax deduction.
- Current market: Demographic changes mean that townhouses are increasing in popularity due to their greater affordability combined with access to space. Low supply is pushing up prices and vacancies are at record lows in inner and middle ring suburbs.
- Yield: Yield is greater than for houses but usually lower than for a unit.
- Capital gain: Capital gain potential is greater than for units, although less than for houses. Landlords have more flexibility and control over improving the capital growth than for a unit.
- Expenses: There are fewer maintenance expenses than for a house, but more than for a unit. Strata fees are less than for a unit.
- Location: Townhouses tend to be located in areas of high rental demand.
- Features: Some features may not appeal to some tenants, such as shared gardens and walls or restrictive pet rules.