The difference between residential and commercial property investment

According to the investor, apart from one of his investments in Tasmania that provides the perfect balance between cash flow and capital growth, his commercial investment in Victoria is easily a top performer across his portfolio.

“The commercial property just gives me no maintenance and no phone calls, just cash flow and a passive environment. Together with the unit block in Tasmania that gives me both cash flow and capital growth, this just changed the portfolio for me.”

Similar to residential property investment, investing in commercial properties entails significant financial responsibilities – from securing capital to maintaining good serviceability.

However, in terms of financing, commercial property investment could be ‘quite open’, Mr Paliwal said.

“You can get commercial properties that might be capped at 60 or 70 per cent loan and some will actually even go to 80. If you’re making the right purchase and you understand what the banks like and don’t like, you start to realise that you can get more out of your borrowing capacity.”

How can traditional residential property investors make the right decisions in the commercial property market?

Fundamentals

When applying for a loan to purchase a commercial property, Mr Paliwal said that banks typically look for the same fundamentals as they do with residential properties, including good location and potential for wealth-creation.

He explained: “If you’re buying in a location with a lot of footprint, a lot of commercial activity, the banks are going to see that property in a different way than they would a commercial property in a very, very small region in the lifestyle area.”

“They will also consider how many people could actually go and rent this. If you have a shop-front, that could go to a barber, clothing store, nail salon and so many different things, whereas a carwash might only be there for a carwash. Banks sometimes don’t like specialised assets because they think, ‘The pool of people who could give you this income to allow you to keep paying the loans is smaller’, so they might let you borrow less.”

Similarly, aspiring commercial property investors will also have to prove a good financial standing and how it will fit into the financial requirements of the desired asset.

“There are other layers to consider, including the income that you earn, the potential yield, how that fits into your borrowing capacity, as well as how long the lease is,” Mr Paliwal highlighted.

Finally, and most importantly, the asset must have great investability and potential for longevity in the market.

“Some banks are willing to give you loans without a full financial overview and focus on the commercial asset only because they see how strong it is in the income aspect, but if the lease is below 12 months, they’ll say, ‘Well, it look strong and nice, but will it be there for long?’ So, when you start having longer leases, that’s another thing the banks will like.”

Commercial properties in action

While acquiring commercial properties could be a bit similar to purchasing residential properties, renting these two types of real estate asset out will be two totally different experiences, according to Mr Paliwal.

For one, the demand for commercial properties could be less than that of residential properties.

“Not everyone needs a roof for their business but every person needs a roof over their head… I need a roof over my head to sleep on but I don’t need a retail store roof to go and operate my business on all the time.”

“And because everything is so specialised to a certain group of people, it can take longer,” he said.

How can investors alleviate these risks?

According to Mr Paliwal, the keys to success in the commercial property investment space are very similar to those in the residential property investment space: Education and due diligence.

Where appropriate, investors may also seek the guidance of professionals in order to make the best decisions for the growing portfolio.

“If you just have more knowledge around what to check, you have a higher chance to succeed. What is the average vacancy times here? What about the industry in a high level, is it in demand or is it something where the landscape is changing with a lot of disruption?”

“It’s a fact that vacancies can go on for months and sometimes years in some places, but it may also be fiction because if you have the right due diligence in place, you can really minimise and increase your chances of success,” Mr Paliwal said.

How much will it cost?

Meanwhile, according to the investor, maintaining a commercial property will not cost more than maintaining a residential property, contrary to popular belief.

In fact, the process is likely to be easier on the investor as tenants are typically more willing to keep the property in its best condition.

“Majority of the assets have the four walls around it. Most of the fitting is done by tenants, most of the things are well-kept because, unlike residential properties, someone is there every day. There’s foot traffic, or someone may be calling, someone maybe dropping off something. So, there’s this need to keep the premises clean, tidy, up-to-date and functional.”

“Your tenants have that level of care because this is the place where they make money. You can just look back and go, ‘I'm lucky to have less work and less maintenance.’”

Once his serviceability recovers, Mr Paliwal looks forward to buying more commercial properties for his portfolio.

“Residential and commercial properties don’t move up and down the same way. Commercial properties have the ability to snowball from an income perspective, but what makes it difficult is obviously having to build a bigger deposit each time and having that equity growth to be able to tap out.”

“Owning commercial made me really realise that you need a portfolio of multiple residential properties with minimal debt to really generate an income that you’d like. So, I thought, ‘Hey, do I want to go down the pathway of just trickling on a $1,500 passive rise or $2,000 passive rise, or could I move with something that’s going to give me $10,000 tomorrow after it settles and start moving like that annually?’”

“I have residential properties in some parts moving well while others are down or flat. With commercial, even if capital growth movements change, when you consider the total return, you will see that the numbers are quite strong and quite positive,” he concluded.

Tune in to Arjun Paliwal’s episode on The Smart Property Investment Show to know more about building a lucrative and diversified portfolio with residential and commercial properties.