Why frustrated property investors are going commercial

Residential property investors frustrated with low rental yields, rising vacancies and patchy capital growth are turning to small-scale commercial real estate in droves to get higher returns.

Residential properties are currently achieving a gross rental yield of 3.9 per cent on average compared to the 7 per cent yield generated by commercial real estate.

Sydney-based investor and founder of Rethink Investing Scott O’Neill said most investors switching to commercial were chasing cash flow, which has been elusive in residential investments.

“A lot of the residential markets are just not performing as well as they used to and there are a lot of mediocre returns out there,” he said.

“The days of 8 per cent capital growth in residential seemed long gone. Rents have dropped in many areas, vacancies have risen and some states are changing tenancy laws in favour of tenants, which make residential less attractive.”

Mr O’Neill, who recently bought four commercial properties, said that while commercial yields have dropped due to rising prices, they are still more attractive than residential yields.

“Two years ago, we were getting between 8 per cent and 9 per cent, now it’s down to 7 per cent on average, which is still really high compared to residential,” he said.

“If you look at the cash flow, it’s probably three times better than residential.”

One of Mr O’Neill’s recent purchases was a warehouse and an office on a 125 square metre block in a tightly-held market in Clontarf, located 29 kilometres north-east of Brisbane’s CBD.

For $425,000 purchase price, the property was getting $30,000 net rental income a year which equates to 7.1 per cent net yield.

“Because the tenant pays all the outgoings like the utilities and rates, I’m netting $13,000 a year cash return,” he said.

When compared to a standard 3-bedroom house at the same price point within the Brisbane metro area, Mr O’Neill estimates that investors will be around $2,073 out of pocket at the current rate.

Commercial property specialist and investor Helen Tarrant said the number of inquiries for commercial investment has gone up by 30 per cent in the past three months.

“We’re seeing a real boom in the small-scale commercial real estate investing,” Ms Tarrant said.

“Even small residential developers are shifting into commercial because residential land is so expensive at the moment, so it’s not worth their while developing.

“Whereas if they buy an older commercial property, they can refurbish it, put a tenant in there and increase the value.”

Mr O’Neill said the number of clients looking to buy commercial property has doubled since August.

“We used to get 25 clients each week, now, we’re seeing at least 50 commercial buyers,” he said.

“Most people are a bit frustrated with their residential investments because they haven’t had the results they thought they’d get.

“Obviously we’ve just come out of a major downturn so a lot of people are still feeling burned by that and commercial seems like a better alternative to help them get back on track.”

With interest rates at record low 0.75 per cent, Mr O’Neill noted that retiring Baby Boomers who rely on regular income have also turned to commercial investment to boost their cash flow.

“Many people find it hard to rely on the rent they’re getting from residential properties,” he said.

Despite the attractive cash flow potential, Ms Tarrant said it’s important for investors to choose the right type of commercial asset.

“Not all commercial properties can deliver the cash flow you want and some are riskier than the other,” she said.

“Stick to assets with a trade base, like a warehouse or office space that cater to professional tenants like dentists, accountants, lawyers, or financial planners.

“These tenants are stable and once they’re established, they don’t want to leave.”

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