Commercial property potentially offers a faster pathway to a comfortable retirement than residential due to its lower outgoings and often higher rental yields.
Despite booming prices and plenty of capital growth in recent years, the reality for most Australians is that they’re just not going to be able to comfortably retire off a residential property portfolio alone. As comfortable as many Australians are with investing in residential, the reality is that a yield ceiling will limit the potential to produce enough income with which to retire. Commercial property within a portfolio can help in generating a workable passive income for an early retirement.
Here’s some numbers that are easily digested and could help feed the retirement years within ten years.
Compare and contrast
Let’s run some maths on what $1,000,000 cash can do with leverage in terms of cash flow in a residential versus commercial scenario, as this is roughly the amount needed to have a chance of retiring from property.
Residential option
To maximise the yield, I would suggest splitting your $1,000,000 into four $900,000 properties rather than one high value/lower yielding residential property. Four properties of this value would require roughly $925,000 using 20 per cent deposits and factoring in stamp duty and other purchasing costs. The other $75,000 would be a sensible buffer to have in place for day-to-day expenses. Now for the cash flow side of things.
At a 4.5 per cent gross yield and using an 80 per cent loan for maximum leverage and avoiding lenders mortgage insurance, the net income from each property after all costs would be a $510 loss. So, multiply that by four properties and you are losing $2,040 per annum before tax. So naturally, you won’t be retiring on a negative cash-flow property.
Commercial option
Now in this case I would recommend either purchasing one commercial property or two. Using $925,000 and keeping a $75,000 buffer again would allow you to purchase $2,500,000 worth of commercial property. Note, I wouldn’t split your deposit between more than two properties as they would start to be cheaper lower quality assets. With commercial property, quality is key to maintaining continual uninterrupted income.
Now for the cash-flow side of things with commercial property. At a 6 per cent net yield and using a 70 per cent loan for maximum leverage, the net income after all costs would be $93,500 per annum. Looking at this basic comparison using the same deposit, there is a $95,000 per annum cash-flow difference between commercial and residential property.
This is one of the reasons for the large difference in income, as commercial tenants pay all the outgoings, such as council rates and maintenance, land tax and insurance after costs. People often think commercial is a highly expensive asset class that requires millions of dollars to get into, but the reality is that you can find a commercial property in a capital city for $250,000 cash, or sometimes even less.
With a good tenant in the property, a longer-term lease than residential, and cash flow that is much better than residential returns in the current market, investors are increasingly looking to commercial opportunities. Even a 6 per cent net yield on an entry-level property priced between $700,000 and $750,000 offers $26,000 passive income after mortgage costs. This is $500 per week in your pocket.
Debt reduction strategy
Commercial property is currently garnering more attention by investors than ever. In recent times this has created rapid capital growth rates for the asset class. Some markets have grown in excess of 30 per cent over the last two years and are still growing.
By using the high net incomes from commercial property rent to pay down the loan, we’re able to pay debt down to zero in half the time of a standard 30-year loan contract, sometimes even sooner. And this is how high-yielding commercial property can pay itself off in 11 to 14 years.
The high cash flow from the net commercial lease can be so strong, that if you can put the surplus rent back into your mortgage or offset account, the debt will be rapidly reduced, without having to make any extra payments.
If you have a strong lease in place, you’ll also benefit from the built-in annual rent rises, which will help you pay off the property even faster each year.
DISCLAIMER: The information in this article does not take into account your individual objectives, financial situation or needs. We recommend that you obtain financial, legal and taxation advice before making any decision.