Commercial property versus residential property – what’s the best investment?

Property investment is as Kiwi as it gets when it comes to New Zealanders investing their money. But is the traditional emphasis on residential ownership declining as commercial property offers advantages well worth considering?

Residential property as an investment class
2017 research found 63.2 percent of people own their own home and this figure has been decreasing, falling from a record high in 1991 of 73.8 percent. This implies that an increasing number of residential properties are available for lease, and consequently as an investment class, residential property has increased over this time.

This increase in popularity of residential property for investment purposes has subsequently made it a target for government intervention.

In recent times we have seen the removal of depreciation claims on buildings, Loan to Value borrowing restrictions, foreign investor restrictions, extensions to the bright-line test (from two years to five years) and the soon to be introduced elimination of ‘negative gearing’ where investors will be unable to offset excess deductions on residential rental property against other income. (This is expected to be introduced 1 April 2019.) A comprehensive capital gains tax has been well signalled and looms on the horizon.

From 1 July 2019, rental homes must have both ceiling and underfloor insulation. In some regions, satisfying the requirements of a housing ‘Warrant of Fitness’ while not compulsory, is becoming expected.

All of the above have been introduced to achieve (or in some cases to be seen to achieve) various social and political outcomes. The cumulative effect is that vanilla residential property investment outside of the family home is no longer the attractive investment Kiwis have come to know and love.

Commercial property ownership becoming more accessible
Commercial property on the other hand has not yet been targeted to the same degree. While it is expected that capital gains will apply at some point in the future, there is currently no bright-line test or negative gearing restrictions in this sector.

Commercial property by nature has always been a more complex area, at times involving extensive lease agreements that detail the terms and responsibilities of both landlord and tenant. Another key difference is that GST applies to commercial property whereas residential property is generally exempt from GST.

There are often other barriers to entry such as the level of investment required that has meant this investment class has traditionally been out of the reach of Joe and Jane Public.

Newer investment products, such as Listed Property Funds and Commercial Property Syndications have made the commercial property sector more accessible by allowing smaller investment parcels, professional property managers and expert legal support.

The sourcing of property stock, arrangement of syndicates, lease negotiations and ongoing building maintenance are all outsourced. Investors then receive monthly or quarterly returns.

Airbnb opportunities
There is an interesting crossover between residential and commercial property that has become increasingly popular in recent times. That is the evolution of short-term stay residential property. Commonly known as Airbnb property, assuming the name of the popular online booking site. This type of property has all the traits of residential property but is run as a commercial operation.

This means a crossover of different rules and regulations. The bright-line test still applies, and this type of activity also meets the definition of a taxable activity for GST purposes. This point in particular can catch property owners unaware especially in cases where they operate another GST activity already, as the requirements for GST are on a per taxpayer basis, rather than a per activity basis.

Common ownership structures
The most common structures used for owning commercial property are Limited Companies, Limited Partnerships and Portfolio Investment Entities (PIEs). Residential property is more commonly held in Limited Companies, Look-Through Companies, Family Trusts or directly by individuals or partnerships. Each of these entities has a different legal and taxation profile each with its own with advantages and disadvantages.

If you’d like to explore the different investment opportunities presented by residential property or commercial property, structures and tax issues relating to directly-held or syndicated investments, click here to contact a Moore Stephens Markhams advisor.

Prepared by Dunedin director Charles Craw. Charles has a special interest in commercial property, residential property, and financial market investments and the various taxation issues surrounding these.