There is a general consensus amongst some individuals that commercial property is a much better investment than residential property. In my carefully considered opinion, I believe this is simply not correct.
During the "recession we had to have" between 1989 and 1993, many accountants and financial planners concluded that commercial property investment was not advisable for their clients. During the 1980’s, I recall many investors who believed residential investment was simply not for them; they thought residential property was for the mums and dads of the world, for beginners or people without wealth or business savvy. They had convinced themselves that residential property was somehow below them; how wrong they were.
I recall a renowned and successful business associate and friend of mine, who heads a prominent accountancy and financial consultancy business in Australia, speaking to me in the 1980’s about his personal property investment strategy. He said:
“John, the yield is so poor in residential property. Commercial property net returns are a good 3% to 5% above residential property. I am developing an industrial show room, and my initial yields will be excellent. Many of my clients really won’t be interested in residential property investment."
I remember thinking at the time his property strategies didn’t sound quite right to me, however I fully respected his determination and accumulated wisdom. In fact, I remember feeling quite junior and inexperienced at the time. I also remember those industrial show room properties not being particularly straight forward for him to manage.
To be clear, through the 1980’s and 1990’s, many John Hopkins clients purchased commercial property. We believed it was an appropriate investment at the time, although we don’t generally recommend it to many of our clients anymore, unless their property portfolio has enough balance to do so.
When considering any quality property investment, you need to be certain that if the property becomes vacant, you are able to find a tenant again quickly. With commercial property, finding a tenant can be difficult if it’s not in the right position.
When it comes to commercial property, many individuals are attracted by agents offering long ten year leases, with ‘government’ or ‘multinational listed corporation’ tenants. If those are the thoughts that make you feel good and confident about your investment for you or your client then respectfully, you are focusing on the wrong things.
Commercial property is only a good investment if you’re not going to have a problem finding a tenant during the hard times. Think for a moment about a commercial property in Acland Street, St Kilda, or Oxford Street, Sydney, or Coronation Street, Brisbane. If you or your client owned a commercial property in any of these streets, and the shop was vacant, you would be able re-lease it in a day, regardless of a recession or GFC. The problem is, to purchase commercial property in these sought after areas, is very expensive.
We recommended our clients purchase 24 shops in Bay Street, Port Melbourne in the late 1990’s, which were just great. However, they didn’t come cheap and therein lies one of the problems with quality commercial properties; most individuals can’t afford them.
If you wanted to purchase quality commercial property in Sydney or Melbourne, it would cost you somewhere between $1.5 and $2.5 million dollars. At this cost, it’s simply out of reach for most individuals, and often doesn’t offer an appropriate spread of risk in their investment portfolio. And remember, the market yield for that absolute quality commercial investment will be around 2% to 4%.
Does that tell you anything?
Why is a low yield low and why is a high yield high?
If we assume standard market conditions, a high yield means low demand of purchase, which often creates a low demand of occupancy. These occurrences together suggest low growth of both capital and income.
On the other hand, a low yield means high demand for purchase because history has told us for hundreds of years that high demand provides high growth of both capital and income, with an incredible demand for occupancy.
Understanding yields, risk and rewards isn’t something that’s popped up recently in Australia; it was figured out and proven thousands of years ago in all the markets of the world, from the time of Babylon in 3rd millennium BC.
It’s not luck or a quirk of circumstances that medium-to-high density residential property, in the best inner urban areas of the major metropolises of the world, returns net yields of 3% to 4%, whilst many commercial properties returns net yields of 7% to 9%. Commercial property is more risky as it doesn’t have the same levels of demand as prime residential property; demand of both occupation and ownership that will give high levels of Security, Flexibility and Returns.
The final issue is that owning residential property investments, in comparison to commercial property, is that it’s easier to hold, even though this may go against popular public opinion. Yes, there might be tenancy changes, or carpets to replace, or painting to do in residential property, but I can say without any fear of contradiction, if there is a problem with a commercial property, and you don’t quite know what you’re doing, there could be a real problem. Unlike major corporations who have the support of a suite of lawyers, you may struggle to find the professional advice often required when problems arise.
In summary, we advise our clients purchase 10 to 15 residential property investments, with substantial equity, before they become a commercial property investor; and we’ve said this for over thirty years.
I am confident this advice is correct.
Scott Keck, Managing Director of Charter Keck Kramer, delivered a presentation in 2009, and said “our advice, which I take myself, is that until an individual has $10 million dollars in equity in residential property, they should not be commercial property investor”.
If the past is an indicator of the future; he is correct. No doubt.
It might not sound to scientific, however I urge you to encourage your clients to purchase medium-to-high density residential property in the best inner urban areas of a major metropolis (in Australia, that is Sydney, Melbourne and Brisbane), put those investments in their back pocket, and forget about them.
If you would to make an appointment with a John Hopkins Property Adviser, please contact our Client Liaison Officer on 1300 726 082, or click here to email, to arrange an appointment for you.