Ask Mark Munro what he likes about investing in commercial rather than residential real estate and he’ll tell you emphatically that he no longer dreads late-night phone calls. As a residential landlord, he would get calls from tenants at all hours of the day or night. Now his tenants are business people, the calls come during business hours. What’s more, he gets a better return from his commercial property portfolio with less management, leaving him more time to focus on deals.

“With residential property, lots of small things become big issues. You always get late night calls — the hot water cylinder’s burst or the neighbours are having a rowdy party — and you tend to get tied up a lot in dealing with small things that don’t actually turn any profit. With commercial property, you’re dealing with somebody running a business who has more incentive to look after the property, they tend to be more business orientated when it comes to discussing leasing issues, and you have more time to spend actually doing deals, which is where you make your money, not running around chasing a tenant for $100 that they haven’t paid you.”

Christchurch-based Munro started out investing in residential real estate and moved along a traditional route buying cheap properties, doing them up, and building up equity to move into commercial real estate. Why? As a hands-on investor, it made so much more sense, says Munro, who became a full-time property investor in 1989.

Commercial real estate gets a better return, the tenants pay out-goings and leases are usually long term. Against that, investors need more money upfront because commercial properties are more expensive than residential real estate, demand for commercial property is tied to economic conditions and investors need better equity.

But take that need for more equity, sometimes seen as a downside. Munro sees it as positive, pointing out that an investor with more equity in a property is less exposed to the whims of the market.
And the yield from good commercial property is around 7.5% to 8.5%, says Munro. That’s net. The usual expenses associated with residential investments don’t apply in the commercial world where tenants are responsible for maintenance and tend to look after the property because it’s in their best interests.

There are plenty of residential investment properties being sold for a gross yield of 4% to 5%, says Munro. And landlords still have to pay property expenses like rates, insurance and maintenance and spend time crawling around a roof fixing leaky guttering.

“With commercial property you get a net return and the tenant pays any cost in management if you so desire. It’s a no-brainer as far as I’m concerned.”

The Property Council’s Investment Performance Index shows that commercial property investors got an average return of 18.13% in the year to June 2005, driven by a strong increase in capital value.
Demand was strongest for office space in the Wellington CBD, which delivered a total return of 24.57%, up from 13.82% to June 2004.The Auckland CBD office sector delivered a total return of 15.34%. The industrial sector recorded a total return of 22.78%, up from 13.75% the previous year.

So why would any sane person stay in residential investment? Partly because it’s in everyone’s comfort zone. More often than not investors start out in residential property because it’s familiar and it’s easy to get into the market. Banks will lend up to 100% on a residential property compared to 60–70% on commercial property and, with the way houses prices have been shooting for the moon, it can all seem so simple. Buy a house with a small down payment, get some tenants in and wait for the value to double or triple.

But any experienced investor will tell you that what goes up must come down eventually. That’s why they call it a property cycle. A rising property market and good capital growth can hide a lot of bad investment decisions.

And experienced investors often move into commercial real estate, as Munro did. It’s a logical step once an investor has built up a residential portfolio, gained some equity and experience in the machinations of property investing, like dealing with banks, says Colliers International managing director Mark Synott. “They practise on residential and when they get serious, move into the commercial sector.”

And they often wonder why they didn’t make the move sooner, adds his colleague Alan McMahon. “We get that comment all the time,” says Synott.

But while McMahon and Synott are happy to point out commercial real estate offers a much better return with a lot less hassle than residential real estate, they don’t advocate going in cold, simply because there is more to learn. Get some experience, says Synott, or consider investing in a property trust or a syndicate first. Then find a more experienced investor to pair up with once you want to become a hands-on investor.

Of course there are pitfalls. Commercial real estate depends on economic conditions and the gap between tenants can be much longer than residential real estate. Peter Aranyi, who recently published a guide to investing in commercial real estate in New Zealand, says an empty building is the worst fear because commercial investments are based on cashflow.

Aranyi offers several rules. Don’t be in a hurry, which sounds eminently sensible but he remembers standing in a real estate office insisting there had to be more properties on the books because he was ready to buy.

Know the real value of a property and know what market rents are in the area. Read as much as you can. Become familiar with leases. Get out there and do some research.

Choose a focus, says Aranyi. Find a sector and research as much as possible. It may be the industrial sector in Albany (north of Auckland) under $2 million.

“After two months’ research you may decide that it isn’t a good idea but you may uncover a bargain. You don’t know until you get out there and do the hard work. The way to recognise a bargain is to look at enough properties to instinctively recognise when one is a bargain. In the commercial sector that may be a property that someone has owned for 35 years where the leases haven’t been kept up to date.”

Munro offers similar advice. “I say to people, ‘wait until you’ve looked at 50 properties and have an understanding of the market’.”

Aranyi also stresses the importance of using a good team of professionals such as lawyers and valuers. And understand clearly the different classes of commercial property — retail, office and industrial — and the associated characteristics and risks. Industrial property is generally simpler while retail can offer a better return but with higher risk.

And if you’re still wondering whether or not investing in commercial property is worthwhile, the last word goes to Munro.

“I had three houses last year. I demolished them quickly to do a commercial development. I could have rented them for 12 months, but I can do without the hassle.”