Faced with the prospect of more moderate returns from their residential property investments, some investors are wondering if they should consider commercial or industrial properties as an investment. Others have noticed that most of the institutional property investors as well as the investors you read about in the BRW Rich 200 list own mainly commercial properties.

On balance commercial property sounds very attractive….

·Would you like to get a rental return of six, seven or even ten per cent instead of the three or four per cent you are receiving from your residential properties?

·Would you like your tenant to pay all the outgoings like rates taxes, insurance and even managing agent's commission?

·Would you like to find a tenant who would take a three or five year lease and not a twelve month lease?

·Would you like to find a tenant that maintains your property for you, but at their expense?

Well that's what you may get if you invest in commercial property, making investing in shops, offices, factories or warehouses sound very attractive, but there are considerable differences between commercial and industrial properties compared with residential real estate. The main ones can be summarised as follows:-

1.    Commercial properties tend to yield a higher return than residential properties - usually between 7-10 per cent net; compared to residential properties which yield 3.5-5 per cent gross (then you still have to pay the rates, taxes, insurance, etc.). The professional investors require a higher rental return from their commercial properties to make up for the longer vacancy factors and potentially higher risks and poorer capital growth.

2.    With commercial properties the tenants usually pay all the outgoings such as rates, taxes and insurance, while with residential property the landlord pays these.

3.    Leases for commercial properties tend to be for longer periods, often three to five years, as opposed to the single year lease you get from a residential tenant.

4.   Because your tenant conducts their business from your commercial property, they tend to look after it better than residential tenants do, usually maintaining and painting the property.

5.   I find commercial properties less management intensive. In fact, we manage our own commercial and industrial properties, but I hand over the day-to-day management of our residential properties to a property manager ... I don't want to be bothered with leaking taps.

6.   Lenders will usually only lend up to 70 per cent of the value of commercial or industrial properties. I don't know of any mortgage insurers who will lend on commercial property. This means the investor needs to come up with more equity to purchase a commercial property.

7.    The initial capital required to get into a good commercial property is usually considerably higher than that required for residential properties, as a good shop or office in a strong centre may cost two or three times the price of a unit or apartment. Sure, you can buy cheap shops in secondary centres, but they will usually have secondary tenants who are more likely to go broke and leave you with a vacancy.

8.    Interest rates for a loan on commercial properties are usually higher than for residential properties - at present about one per cent higher, but a savvy mortgage broker could help you here.

9.    When vacancies occur in commercial properties they are often vacant for considerably longer periods than the week or two you may have a residential property vacant. How often have you seen a shop in your community shopping centre vacant for weeks or months?

10.  The cycle for commercial properties is different to that for residential properties and is even more dependant on the general economic factors than the residential market.

11.  The lease required on a commercial property is much more complex and usually requires a solicitor to prepare it.

12.  It's easier for you to pick a top-performing residential investment. Most beginning investors know what to look for in a residential property - they have lived in a house - but few would know what a tenant looks for in a good commercial or industrial property unless they have conducted their own business from one.

Now that you understand some of the differences between residential and commercial property investments, you will understand why they can't be purchased using the same criteria. Yet I see some investors buy shops, offices or factories using the same rules as they use to choose a residential property. This can lead to trouble.

Commercial properties are valued based on their yield - on their rental return and on the security of their lease. Yields vary depending upon the area, the type of property and the security of the lease. (A lease to the ANZ Bank would be considered more secure, for instance, than to a start-up business, and investors would be prepared to pay more for this property.)

Since they are mainly yield (cash flow) investments, capital growth of commercial proeprties is in line with rental growth. Therefore your lease should incorporate regular rental increases, either fixed at three or four per cent, or according to the C.P.I. index.

If you are a beginner in commercial or industrial property, avoid buying properties without an existing lease. Sure, having a tenant in place increases the value of the property (and how much you have to pay for it), but vacancy periods can be long - possibly six to twelve months - and this is crippling to your cash flow.

My personal experience of owning a large portfolio of commercial and industrial properties is that while we have had very few vacancies over the last 20 or so years (as one tenant moved out another moved in because we have owned the right type of property and manage them ourselves), our capital growth on these properties, even though they are in prime positions, has been poor compared to the growth of our residential properties.

In general, I believe residential property is a safer choice for the beginning property investor. As you become more experienced, and have more substantial assets, you could consider adding commercial properties to give your portfolio some balance.