Capital Growth - higher in commercial or residential?

Is capital growth higher usually with commercial or residential? With commercial the the value of a property is generally based on the yearly net rental return & type of industry of the tenant, right?

Most rents also increase by CPI every year giving negligible capital growth, unless you have rents increase by 5% a year, which would be very rare. Alternatively if you buy the property with a high cap rate then sell it later on a low cap rate.

Thoughts/comments?

 

Like for like residential (historical) land seems to have a higher growth rate than commercial land while residential buildings maintain better value than commercial.
Commercial has a higher cap rate.
Comments; there are too many variables in the value of properties to comment in one sentence.

 

Capital growth is a function of supply over demand. If the demand outstrips the supply of an asset, the value will grow regardless of the type of investment. (assuming people have the ability to pay for the new price)

Yes you are correct that a lot of commercial property’s value is associated to the net rental value. However you must also consider the Capitalisation Rate of the area. In recent times we have seen Capitalisation rates drop sharply as investors take advantage of low interest rates (increasing demand) allowing them to pay more for investments.

The lower the cap rate the more someone is willing to pay for the net rental income. Example:
7% cap rate - $70,000 of income = $1,000,000 purchase price
5% cap rate - $70,000 of income =$1,400,000 purchase price

When the cap rate gets lower for an area or asset class this is called yield compression. Yield compression is one of the most powerful tools out there for capital appreciation. I thought I would share one of my clients recent results that was bought and sold out of.

ACT Property

33 Gartside Street, Wanniassa ACT 2903 - Sold Other Property | Commercial Real Estate

Purchased: Oct 2018 for $6,450,000

Sold: 21 Dec 2020 for $8,350,000

=29.5% capital gain in 2 years and 2 months

please note this was also a 8%pa net yield throughout the holding period as well. So you get both good growth and cash flow!

I’m not really into the whole residential verse commercial capital growth argument, because you simply cannot generalise on a macrolevel. All I can say is my experience with commercial has seen much better capital growth results on average due to mostly yield compression in recent years.

Scott O’Neill

 

Retail CP is probably more popular, office/industrial/warehouse, not so sure the capital growth & extended vacancy ?!

 

Absolutely no bearing whatsoever. Retail, like any other commercial, is subject to the vaguaries of the market and the economy.

A new retail development will suck up retailers, offer incentives to vacate existing premises etc. This may skew the dynamics of the high street as the new shops will offer underground parking, lifts, security, cleaners, air conditioning etc - this leaves the high street looking like @datto's best mate's teeth (not the gold one).

As for whether there is better cg for commercial, totally subjective. It is better to look at total return (CG + net CF) rather than in isolation and to compare both investments via a detailed DCF and IRR factoring in all known costs/income.