Commercial property investment vs residential investment

Hi. I have another query...and it is a bit hypothetical case but it is an option my wife and i are now considering.

We currently have an investment home we've owned for 11 years and if we sell it, could earn $500k profit (after cgt etc). The reason we are selling is that Unfortunatly the current rent return is poor (after deducting loan repayments). But the house has appreciated about 500k since we owned it.

We do not want to simply put this money(profit) into our bank account. Having a few younger kids, we are thinking about their hardship in the future to even afford a home for themselves. So we wanted to wisely invest the $500k- in commerical property.

An opportunity has arisen for us. We have a good relationship with my wife parents. And they are thinking about buying a $2.6mil commercial property at 4.5% net yield.

If we go in as partners, we would own 20% they would own 80%. And of course the rent is apportioned.

The yearly net rent return for us would be over $22k and significantly higher than the mesely $1500 profit from out current rental home. And of course we would own 20% of the commercial asset.

Does anyone have experience in doing what we are considering. Or anyone have some other helpful ?

 

Couple of things to consider.
Assuming capital city resi, the return is in the future cg, not so much rent.
While the commercial has better yield, do you sacrifice cg? Have you compared the future value of the resi property with the expected cashflow and future value of the commercial property?

buying with family has its potential issues. You might be assessed for the whole amount, lowering your future borrowing power. If one party has problems paying. What are your inlaws experience with commercial property, or property in general? Family and succession issues.

these may or may not apply in your case.

 

Excellent points raised there. So thank you !

We did assume that the capital gain in the commercial property was the same as the resi. But to be honest am not sure if commercials follow the same trend in cg??

To give u an idea. This resi property has increased as follows. Bought for 168k in 2001, then 450k in 2009, and now in 2021 is worth 770k.

We were planing to add a bit of our savings so that our total invest amount (came to an even 500k) and invest in commercial.

Cash flow in resi is only 1500 per year at the momnet ... but the capital gain is quite healthy.

The inlaws have purchased commercial in the past and are doing well....but you do raise good points about succession and borrowing power, which indid not consider.



*** one idea we are toying with is using our all our savings to pay out the resi loan and effectivly positive gear... but i am a bit concerned throwing so much money into the rental home....but the benefit is our resi eturn would be 25k per year instead****

 

The other question might be, do you have to sell? Could you refinance to buy the commercial and keep the resi? Depends on your serviceability and risk appetite.

thats a 7.9% per year appreciation on the resi. If that continued for another 20 years, the resi will be worth 3.5m. Not saying it will, but have you thought about it that way? If it gets near that sort of return in 20 years, are you really worried about cashflow?

 

Trainee has nailed it in both points. If you can hold on to the resi investment, and refinance into 20% of the commercial, that would be "winning". Resi yields are going to zig zag higher over time, but I wouldn't sell because of 1-2 years of poor yield if the overall asset is good.

 

If i did the latter , wouldnt the bank repayments negate the rental return. Ie i borrow money to invest in commercal (and keep resi), but the repaymejts to the bank would be signifcant.

The reason i emphasise this is that ... that s whats happening with the current resi rental now...albeit it does have good cg

 

You both give me good points to consider. I am going to do some more numbers. I am just a tad concerned on investing in commerical as 20 percent share and paying back a wapping loan...and seeing no immediate benefits.

What about paying out the resi loan now? And leaving it as that..it would positive gear it for us

 

Thats your personal call. But how much cash return do you really need now? Are you willing to sacrifice some immediate returns for potential future gains?

looking at it another way, would you rather have bought a couple of those resi places 20 years ago, even if they didnt pay you net rent?

 

Yep. I see ur point.

I am going to check out leaving the resi as is. Maybe a facelift to it to make it more appealing...and see if we can borrow to invest in commercial

 

What are the details of the commercial properties?
It may seem strange but my biggest regrets have been not buying the commercial that yielded 4% and less not the high 10% plus.
It's the buying the quality properties that I most regret.

 

Hi the properties we have been looking at were tenanted small industrial. Has a brake an clutch tenant. Another is a plumbing supplier. All have about 4.5% yield.

Thats what we were considering anyway.

The resi we have is much less than 4% yield, but as correctly pointed out, has a high CG.

 

The lease terms for those 2 i mentioned were for another 4 years with 3% yearly increase. The existing tenants have been there a long time

 

Location is important to both of those tenants, moreso the plumbing supply (I assume semi-retail/bulky goods).

If you're able to hold the resi, I'd suggest redrawing against this (without crossing) - you may be able to take this at resi rates

CG will still happen however this is not the main thrust of this type of investment, it's the cashflow that it generates. The tightening of yields has already happened (may still have a little to go) so CG won't be massive for several years.

You need to weigh up whether borrowing to buy and paying back the resi loan quickly (under Low interest rates) is better than deploying the additional cashflow elsewhere or selling & paying a whack of CGT to start again is advantageous.