Commercial Property Investment in Australia: The Comprehensive Guide
Most property investors in Australia start with residential property investment. However, as you get past your first (or second) property, commercial property investment may hit your radar, and for good reason. Commercial property offers investors attractive benefits, including much higher rental yields and diversification, but also an increased level of sophistication that calls for deeper analysis, including the aspect of property marketing.
This article will help you understand the fundamentals of commercial property investment, including the critical role of property marketing in maximizing the potential of your investment.
Key Benefits Of Commercial Property Investment
Commercial property investment offers a number of attractive benefits, including:
Substantially Higher Rental Yields
The average residential property in Australia achieves a gross rental yield of around 3.6% (CoreLogic, 2015). However, the average commercial property can generate rental yields of 8% to 12%.
Long-Term Leases
Residential investment properties typically have rental terms of 6 to 24 months. In contrast, a 3-year lease in commercial property is considered short. Leases of 5 or 10 years, or variations such as a “5 plus 5” (e.g., 5 years, with an option to renew for another 5 years), are not uncommon.
Once you have a stable tenant in place, it’s solid long-term cash flow.
Regular Rental Increases
Annual rental increases are common in commercial property. These can be set at a fixed rate (e.g., 3% or 4% per year) or indexed to the CPI.
For example, if you rent a commercial property for $80,000 per year and increase the rent by 4% annually, in 10 years, the rent will be $118,419.
This factor can easily turn a cash flow negative commercial property into a cash flow positive one over time.
Lessee Makes Improvements
The lessee is usually responsible for paying for the “fit-out,” i.e., configuring the office for their use. In a softer leasing market, the landlord may offer to perform certain parts of the fit-out as a signing incentive or in exchange for a longer lease term or higher rent.
Lessee May Pay Some Or All Of The Outgoings
With a residential property, the landlord pays most of the expenses. With commercial property, it is more likely that the tenant will pay the outgoings. In a Gross Lease, the tenant pays one fixed amount monthly without contributing to outgoings. In a Net Lease, the tenant pays a base rent amount plus a contribution to the outgoings.
Diversification
The commercial property market follows a different cycle compared with residential property. Holding one or more commercial properties can balance out the cycles in your portfolio, providing smoother sailing overall.
Better Maintenance and Upkeep
Commercial properties tend to be well-maintained by the lessee, who may even make further renovations like floor restoration, landscaping and others at their own cost to impress customers or clients when sales prospecting.
Tax-Effective Ownership Structures
A business owner can purchase a commercial property via their Self-Managed Superannuation Fund (SMSF) and rent it back to themselves. This is not allowed for residential property and can result in a tenant that will always pay the rent and a long-term home base for the business.
Wide Range Of Price Points
While the “average” commercial property is more expensive than the “average” residential property, there is a lot of variation. Free-standing buildings in regional centers or strata offices in urban centers may be available for much less, and boutique commercial investments such as city carparks may be available for five-figure sums.
Potential Downsides and Risks Of Commercial Property Investment
Where there are benefits, there are also risks and downsides. Here are some of the main ones:
Higher Loan Interest Rates
Commercial property loans carry higher interest rates than residential equivalents. This may be due to perceived greater risk or less competition for the commercial investment dollar. The entire lending arrangement needs to be weighed against the overall potential return of the property.
Longer Vacancy Periods
A well-chosen residential property is unlikely to be vacant for six months, but this can occur with commercial property. When there is a high vacancy rate, commercial landlords often offer incentives and discounts to attract tenants.
High Rental Incentives
To attract good tenants, commercial landlords may offer incentives such as rent-free periods ( rent free periods of 3 to 12 months (or more) are not unusual)or a reduced rent. Once a tenant is signed, the lease tends to be long-term.
Typically Take Longer To Sell
Commercial properties tend to take longer to sell due to fewer potential buyers. It may take 6 to 12 months to sell a commercial property.
More Complex Leases
Commercial leases are highly variable and more complex than residential tenancies. Engaging a competent property lawyer is essential (and in many cases, the legal costs will be covered by the tenant!).
With commercial leases, everything is a negotiation. It’s crucial to read every line of your lease agreement to understand the implications down the track.
More Sensitive To Economic Cycles
Commercial property is more sensitive to economic cycles than residential property. Changes in economic conditions can significantly impact the commercial property market.
For example, prior to the GFC of 2008, commercial office space in city centers was generally priced at a premium – especially in the “mining states” of WA and QLD. But post-GFC, the demand for tenants dried up and vacancy rates were higher. Values fell accordingly.
This goes to show that changes in economic conditions and sentiment can move the commercial property market.
That’s why it’s so important to invest somewhere where you have reasonable confidence that a sufficient pool of potential tenants will exist in order to keep your property tenanted.
Types Of Commercial Property
Different types of commercial properties have different dynamics and therefore different investment strategies. Some of the more common commercial property types include:
- Standalone offices
- Strata offices
- Medical centres
- Retail
- Restaurants
- Mixed use (e.g. Industrial warehouse with office attached)
- Industrial (e.g. factories)
- Boutique (e.g. car spaces)
- Commercial (e.g. warehouses, scrap metal yards etc.)
Commercial Property Ownership Structures
Commercial properties can be owned through any ownership structure. Trust structures with a corporate trustee are common.
Business owners often purchase their business premises via a Self-Managed Super Fund and rent the premises to themselves.
This is essentially the same as paying rent into your retirement fund on a tax-preferred basis, rather than paying rent to a landlord. In the right circumstances, this can be highly advantageous, and we’ve assisted many business owners to execute this strategy.
Facts On Commercial Property Finance
Finance for commercial property is a little different from residential finance, as you’d expect. Some of the key differences are:
- The maximum Loan To Value Ratio (LVR) is usually 70%.
- Commercial interest rates tend to be significantly higher than residential.
- Loan terms tend to be shorter than residential (e.g. 15 years as opposed to 25 to 30 years).
- There may be more special conditions.
- Generally, there is more complexity. Working with a good commercial mortgage broker is a must.
How To Select The Right Commercial Property
Selecting a high-performing commercial property comes down to research and negotiation.
Some of the key factors are:
- Ability to get a tenant – a property with a long-term tenant already in place – or strong pre-existing demand – can be highly advantageous.
- Long-term demand outlook – do you anticipate demand will remain strong? Australia’s rapidly growing population helps, but it’s also important to consider the location and sector that you are exposed to.
- Proximity to infrastructure – for example, warehouse space near a port, or medical offices near a hospital, may be in pole position for constant demand.
- Property-to-demographic match – e.g. suburbs with strong population growth may have demand for more retail space and restaurants.
There are many scenarios where a developer or owner is motivated to sell a commercial property, and with keen eyes, a shrewd investor can swoop in and buy under market value. As we mentioned above, commercial property tends to be less liquid than residential, so if the seller wants to sell more than you want to buy, you have the upper hand.
Keeping your eyes open for such opportunities can give you a distinct advantage in the market.
Get's started
Commercial property investment offers significant opportunities for more experienced investors. Multiple-property owners should consider commercial property to generate higher yields and diversify their portfolios. Commercial properties are typically more expensive to buy and harder to tenant, but with a solid tenant, they can provide substantial long-term returns.
Get in touch with Smart Property to arrange a Property Investment Strategy Session.
We can assist in formulating and executing a comprehensive commercial property investment strategy, including effective property marketing techniques. Our approach focuses on investment analysis, acquisition, and maximizing the visibility and appeal of your investment in the competitive market.
