Investing in Commercial Property – The Benefits and Risks

So you are interested in buying a commercial property?

Commercial property loans are quite different to residential loans and here we aim to cover the ‘need to know’ information for anyone looking to purchase commercial property. Whether this is your first commercial property purchase or you are adding to an existing portfolio this information will make you more confident with the process and the options available and could save you quite a bit of money in the process.  In this post we’ll start with the basics: what is commercial property and what are the risks when investing in it.

Commercial property includes a whole range of options from high rise buildings to small, quirky shops!

What is Commercial property?

Commercial property includes all non-residential real estate and is generally divided into 3 groups – office, retail and industrial.  Within these 3 groups there is a huge range of opportunities to invest, depending on your preferred location and budget:

Office includes different grades of property from premium quality office buildings to basic suburban office blocks; from entire high-rise properties, individual floors of a strata building, to individual offices within a building.

Retail properties range from large metropolitan shopping centres, regional centres, specialist retail hubs, right through to individual shops.

Industrial property often includes sites with custom built structures or buildings that are designed for a specific type of tenant and they can be very individual with cheaper, quicker construction.

Why invest in commercial property?

There are a number of considerations that make commercial property an attractive investment:

Longer lease period:  While residential leases are generally from 6 to 12 months, commercial leases are usually from 3 to 10 years.  If the commercial tenant has spent money on the fitout of the property they are unlikely to want to move in a hurry, which can give you confidence for your cash flow projections.

Higher Returns: Commercial property generally offers a higher Return on Investment (ROI) than residential properties.  Average rental yields for commercial properties was 6.3% in December 2016, according to CoreLogic, compared to average residential yields of 3.1%.

Lower Ongoing Expenses: Commercial tenants usually cover costs such as council rates, water, insurance and body corporate fees so there are less outgoings for the owner than with residential property.

Value Adding by the Tenant: You might make improvements to the property yourself but the other possibility is that the tenants may make improvements which can increase the property value.  This can lead to later increasing the rent in a rent review to reflect the desirability of the property.

Rent Increases:  Lease agreements usually include details of the rent increasing in accordance with inflation.  Since commercial property values are calculated on the rent paid, as the rent increases so the value of the property will increase over time.

Stable Prices: Commercial property prices tend to be quite stable over time compared to residential properties.  There also tends to be less emotion involved in buying commercial property!

What are the Risks of Commercial Property?

There are some risks that you need to be aware of and knowing about them can help you to avoid or minimise them:

Untenanted periods – Any rental property has the risk of being untenanted for periods of time.  This can be reduced by buying a property that appeals to a wide range of tenants; buying a property that has a tenant on a long lease; researching the local market to understand what the demand is for the property now and into the future; and being willing to reduce the rent if required to secure a tenant.

Changing economic factors – You need to do your research into the local economy, be aware of the national economy, the local economy, and the sector that you are going into (retail, industrial or office).  By being aware of any challenges that may affect your investment such as rising interest rates, unemployment, low business confidence you can assess commercial property purchases on their future potential.  Doing your research of these economic factors can be as simple as talking to local business people and commercial real estate agents who have an understanding of them.

How can I reduce the risks?

Keep some funds as a buffer – If the property is vacant you will need to pay for the running expenses such as council rates, insurance and body corporate fees as well as your loan repayments.

Choose tenants carefully – Ensure you have quality tenants so they will look after your property.

Manage tenants well – Whether you do it yourself or use a property manager look after your tenants.  If they are happy and successful they will take care of your property.

Property Inspection – Have the property inspected before you purchase it to make sure there are no structural or safety issues that could bring unexpected costs down the track.

Market research – Make sure you do your due diligence.  You need to know what the prices and yields are in the local area; and whether there are any planned infrastructure changes or major developments happening that could affect your property or access to it.  Visit the local Council and again, speak to local business owners and commercial real estate agents to tap into the local knowledge.

In our next blog we’ll be looking at commercial property investment goals and dispelling some of the misconceptions about investing in commercial property.

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