Residential vs Commercial property investment in Singapore: which is right for you?

Commercial properties are an attractive investment to many right now. Rental yields for commercial properties may reach 5% on average, whereas residential units typically have more modest rental yields of 2 to 3% per cent. However, there are many more differences between investing in a residential vs. a commercial property — vital make-or-break factors that you must know before putting in your money. This in-depth analysis will help you make a better and much more informed decision.

The main differences between commercial and residential investments in Singapore:

• Bigger cash outlay
• Flat tax rate
• Shorter leases are common
• Tenants have different considerations
• Tied to industry-specific cycles
• More hands-on management

1. Bigger cash outlay

You’ll need much more capital for a commercial investment, as opposed to a residential one. There are three main factors causing this.

The first, and biggest, issue is that you cannot use your CPF for commercial properties. For residential properties, you can pay for your property through your CPF Ordinary Account (CPF OA) under the Private Properties Scheme, as long as its within prescribed limits such as the value of your property.

Second, loans for commercial properties tend to have bigger downpayments. The maximum Loan to Value (LTV) ratio for commercial properties is the same as for residential properties — banks can lend you up to 80% of the property’s value. However, borrowers typically get an LTV of 70 to 75%. This is because banks consider commercial properties to be of higher risk as compared to residential properties.

Third, the Goods and Services Tax (GST) of 7% is applicable for commercial properties. So, while there is no Additional Buyers Stamp Duty (ABSD) for commercial properties, the GST makes up for it. Unlike the ABSD however, the GST cannot be paid through your CPF, thus adding onto the higher cash outlay.

2. Flat tax rate

Commercial properties are taxed differently from residential counterparts. The tax rate is a flat 10% of the commercial property’s Annual Value (AV). In contrast, residential properties have a tired tax rate based on the AV of the property ranging from 0 to 16% for owner-occupied properties and 10 to 20% for non-owner-occupied properties. In short, commercial properties for investment tends to be taxed lower than its residential counterpart.

Calculation examples for both commercial and residential properties are available on this IRAS webpage.

3. Shorter leases are common

With residential properties, leases are 99-years, 999-years, or freehold. With commercial properties, leases tend to be much shorter. It’s not uncommon to find leases of just 60 years.

While freehold commercial properties do exist, they are quite rare. They also tend to be situated in more obscure or inaccessible areas, and hence may be more suited for light industrial uses (if permitted by URA) than retail.

You can find commercial properties of all tenures by filtering your search on Singapore’s largest property portal 99.co.

4. Tenants have different considerations

The needs of commercial property tenants are more diverse. With residential properties, the tenants’ needs tend to be quite universal – almost everyone wants to leave near an MRT station, with lots of eateries and retail nearby. With commercial property, tenants’ needs can differ greatly, even within the same industry.

For example, a design agency may need an office space that’s individualistic and shows flair, prompting them to pick a shophouse over a typical office building. And you may think that all retail tenants care greatly about foot traffic, but you could be wrong; some niche businesses, such as companies that sell car decals or sound systems – have customers that will travel to them — they’re not reliant on passing trade at all.

So, while commercial properties can be more rewarding in terms of percentage yield, they’re also less forgiving to landlords who don’t know their tenant demographic in depth.

5. Tied to industry-specific cycles

The fate of a commercial property is tied to its tenants, which is in turn tied to certain industries. For example, retail is currently taking a beating, due to business lost to e-commerce. (In 2016, centrally located malls saw some of the highest vacancies in five years.)

Likewise, a slump in certain manufacturing sectors can impact industrial properties, and economic recessions can hit office properties hard. (Companies downgrade their offices or stop hiring, thus killing demand).

Aside from rental returns, bear in mind that the capital appreciation of a commercial property are intertwined with the relevant industry sectors and are affected by market conditions for these sectors. Shorter lease commercial properties in particular (e.g. 60-year leasehold properties) will see its valuation fluctuate more because of this. In general, the shorter the lease of the commercial property, the more volatile its value.

 

5. More hands-on management

In general, landlords of commercial properties are called upon to do more than residential landlords. For example, if paint is peeling off a wall, a residential tenant might be okay to wait a while — even a few weeks — for you to get it repainted. A tenant in an office or café space, however, will need you to deal with it immediately as it affects their business. Remember even a single day in which a commercial tenant can’t operate can mean serious financial losses.

Commercial landlords are also required to renovate and upgrade the facilities more often because of much higher use and wear and tear. Bear in mind that, as the tenants are business entities, they tend to be more calculative about everything.

A successful commercial landlord also tends to be a go-getter, businessperson type who’re not just satisfied with any tenant. He/she would, for instance, pursue a popular restaurant or a celebrity chef to set up a branch at the vacant F&B unit, and would know how to be creative with rental (e.g. based on revenue) to keep that tenant happy while optimising rental yield — a world apart from residential properties, where the property’s attributes itself does most of the talking.

So, is commercial property right for you?

To invest in commercial properties, you should have the following traits:

• Ability to deal with the higher cash outlay
• A background or deep understanding in the relevant industry
• A higher risk capacity

Commercial property investment doesn’t just require a bigger downpayment. It can also be much less liquid than residential properties (property itself being already illiquid assets). This is because it tends to take much longer to re-sell a commercial property, so you cannot quickly offload it if you need the cash.

In general, if investing in a commercial property would take up all of your investment funds or wipe out your savings, it will be too much of a risk to take. Consult a financial adviser for a second opinion, but it’s likely to echo ours. Basically, commercial property is a good option for those who already own a second residential property as investment and want to diversify. Freehold or 999-years leasehold commercial property can also be a good store of value, case in point being a conserved shophouse in a prime district of Singapore.

Ultimately, it’s advisable to invest only in what you understand. If you don’t know anything about restaurants, for example, it may not be a wise idea to buy and rent out a space with a fully equipped kitchen. You’ll find it’s not just a matter of foot traffic; other factors such as poor parking spaces, a saturation of similarly-themed cafes and restaurants, and even a location blocked by a large sign or bus stop can turn away prospective tenants. Many times, only a veteran in the industry can discern all these factors at once.

If you have the following traits, you may be better suited to residential investments instead:

• You want to be more passive as a landlord
• You have no background as a business owner
• You want a generally less volatile asset, and are okay with a lower rental yield

Residential landlords don’t have to deal with urgent maintenance calls that need fixing right now. They also don’t need to make renovations or upgrades as frequently — it’s possible to go 10 or 20 years with just basic maintenance work for a house. Because of the maintenance demands of commercial properties, it’s also essential to factor in maintenance costs while calculating true rental yield; many investors opt to hire a commercial property management company to attend to the property’s and tenant’s maintenance needs — which can amount to a significant sum of money.

It’s also worth considering residential if you frankly have no business background. Unless you’re willing to learn what a logistics business needs in a warehouse, what sort of chemical safety procedures a light manufacturing plant may need etc., you’re better off avoiding commercial investments. In addition to maintenance needs, these unexpected requirements can cause you to greatly underestimate the costs.

While residential properties have lower rental yields, they also have lower volatility. Although residential properties also have up and down swings, these movements are not as sharp and sudden as most commercial counterparts. For example, a formerly prosperous café can see its rental rates plummet overnight, if the office or school next to it closes (that may have been the entire customer base for the tenant).

In any case, speak to a qualified wealth manager before deciding which asset fits better in your portfolio. Don’t be too eager to grab at a higher rental yield, but don’t assume you lack the capacity for it either. Both commercial and residential properties can boost the right investment portfolio. Once you’ve made your decision, you can head to 99.co to find the best priced commercial or residential unit in any location.

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If you found this article helpful, 99.co recommends 5 amazing retail ideas for shopping malls in Singapore and How to recognise a good property agent when buying, selling, or renting a commercial property

Looking for a residential or commercial property? Find your dream home on Singapore’s largest property portal 99.co!