Commercial vs residential property investing in 2023: Which is better?

With the value of residential property continuing its downward trajectory in Australia, could commercial property be the answer for investors?

The recent decline in residential property values has come about due to interest rate rises, the latest rapid capital growth rate corrections and a move away from negatively geared assets.

Data from CoreLogic shows residential property values are down 8.4% as of January 2023. Many investors are now weighing up their options.

Has commercial property been affected?

Unlike residential property, the commercial property market is stable and improving.

As people who invest in both assets, it's very clear to us that the attractiveness of commercial property over residential is far stronger when interest rates are higher. This is due to the lending costs, which make most residential properties highly negatively geared with debt.

There are also more people trying to sell their homes and fewer people wanting to buy them, which means price declines are widespread for our national residential markets.

Commercial property on the other hand remains solid thanks to very low stock on the market. Demand still far outweighs the availability of properties.

Commercial property investment is also a higher-income asset that requires more money. This means there are fewer investors and less competition as a result.

For this reason, there is more opportunity for strong returns in commercial property. Not just from a cash-flow point of view, but also from a capital growth perspective. Especially if you target the high-demand industrial and essential retail markets, which have more interest compared to CBD offices.

Commercial property market outlook

Here is a snapshot of how we are viewing property markets around the country based on a report from Thinktank Property Finance:

• Residential homes and units are weak and declining in most capital markets (Adelaide and Perth are exceptions)
• Commercial office property is fair to good and stable across all capital markets
• Commercial retail property is weak to good and stable across all capital markets
• Industrial property is good to strong and improving across all capital markets

We have always seen commercial property as a valuable way to invest and put yourself in a strong retirement position. The higher interest rates have also provided a window of excellent buying conditions in early 2023.

This is because when rates start falling (whenever that is), you will see a new surge in demand from buyers plus a greater reluctance from sellers to sell their commercial property. So the smart money will always move against the crowd.

If you're looking to get into the market, here are 4 key things you need to know:

1. Get your finances in order

Before you start, make sure you have a full understanding of your financial and lending position. Each type of asset (e.g. industrial retail, office) might be subject to different lending and loan to value ratio (LVR) requirements. So it's important to have your budget confirmed before you get into the negotiations phase.

As a general rule, it's good to have at least $250,000 in cash or equity to get started.

2. Research the commercial market

Have a full understanding of market values before you start engaging in negotiations. This is a tough one that can take a lot of time to research and get your head around for each market.

A shortcut is to use a qualified and experienced specialist commercial buyers agent. If you don't want to use one of them, a good place to start is by talking to leasing managers to understand the square metre (sqm) rates for rentals to work out fair market rent.

Then you need to understand the fair yields in each area. You can get an idea of yields by talking to valuers or multiple sales agents.

3. Make sure you have a good team around you

To protect yourself, having a skilled commercial solicitor will be a big help as they will help with parts of the due diligence process. A specialist mortgage broker will get you the best lending deal.

A specialist commercial insurance broker will help protect your assets while a good accountant can help structure your purchases in a way to minimise tax and maximise protection. A commercial buyer's agent can get you into the right asset class in the right market at a good time.

4. Decide if commercial real estate is for you

If you need good cash flow and have a good understanding of investing and the property market in general, then commercial property can be for you. If you have never done this before, seek help and advice. The returns you get from commercial property are without a doubt better than residential. However, if you get it wrong the risks can be higher. This is a space for experienced investors and professionals. So make sure you do your research.

Scott and Mina O'Neill are co-authors of Rethink Property Investing (Wiley $29.95) and founders of Rethink Investing, Australia's number 1 buyers' agency for commercial property investors. After retiring at the age of 28, they now live off the passive income generated by their personal $60 million property portfolio and have helped over 3,075 clients purchase around well over $2.5 billion in Australian real estate. Find out how to do the same at www.rethinkinvesting.com.au.