How to shift from a residential to commercial portfolio

Complete transparency. Before COVID-19, it was much harder to distinguish a strong business from a weak one in terms of the ability to pay rent if revenue drops. Today, due diligence has never been easier to complete on a commercial property. This is because a key marker when assessing a commercial property purchase – how a tenant will perform – has been easier to determine during the pandemic. At Rethink Investing, we request bank statements, because from them we can readily check if the tenant has paid 100 per cent of their rent, that they’ve had no rental reduction and no JobKeeper allowances, and if they’ve retained the same number of employees through the tough times. This gives us a lot of confidence in the business prior to purchase, and one more thing supporting the transition from residential to the lucrative world of commercial.

High yields. In an investment world where high yields are becoming increasingly difficult to find, commercial property offers investors a cash flow high enough to generate a significant passive income even after bank debt has been taken on. This places you in a much stronger position if you’re planning for early retirement. And for us, that’s the name of the game. Basically, commercial property can be a gold mine for investors looking to create a passive income for their retirement. Comparing these high commercial returns against current stagnant residential yields, over the long term, provides a clear winner. The choice to swap residential for commercial is an easy one.

Lending is easier. For most investors, securing a commercial loan is proving to be easier compared with securing residential loans in the current lending environment. This is because there are more options to lend. There are options to have standalone loans on the property that doesn’t require your income to back up the debt. This is handy if you don’t have strong financials or are already retired.

Low interest rates. Because they’re at an all-time low and they don’t look like they will rise for some time, it means the net cash flow you’ll receive on your commercial property has never been better. We are seeing rates as low as 1.9 per cent for commercial loans, with the majority of lenders offering loans between 2.5-3.5 per cent for commercial loans in 2021.

Growth. Commercial property is growing in value off the back of falling interest rates and increased buyer demand. There is also a severe shortage of stock. In some areas, stock levels have fallen by 50 per cent, with many owners reluctant to sell their assets while they see no better options out there for making a good return on their investment. Increased demand but lower supply is fuelling the growth equation. Of course, some sectors are suffering (such as the CBD office market, as noted), but others have never seen such great demand. This demand is largely from residential investors who have turned to commercial property in search of better returns. Increased demand over limited supply = capital growth. It’s that simple.

Switching from residential to commercial: checklist

1. Have you hit a yield ceiling? Talk of a yield ceiling among residential investors is alive and real, and one of the biggest motivations for them making the switch over to commercial. When the cash flow is not high enough to take on the debt in residential, then it’s possibly time to increase your cash flow via commercial property.
2. Are you feeling the pinch? If lending is getting more difficult in residential, then maybe it’s time to speak to a commercial broker.
3. Do you already have a few residential properties? Then perhaps it’s time to diversify.
4. Are you nearing retirement age? If so, commercial property can offer faster results and an instant passive income versus waiting decades for capital growth in residential.

Scott and Mina O’Neill, founders of Rethink Investing