Commercial real estate investment has taken on a new glow since the economic upheaval of 2020. Historically low interest rates have sapped the life from bank savings while soaring home prices are making residential property investing more challenging. Amid the shifts the commercial world has mostly proved resilient - some its asset classes more so than ever.
But before diving in agents stress that homework is imperative. Returns from commercial investments may be higher than with residential and benefits more appealing, but the area is also more complex and comes with its own set of drawbacks. “Don’t buy just any commercial property simply because interest rates are low,” said Cal Doggett managing director of West Australia-based investment firm Properties and Pathways. “Look for the fundamentals driving the rent.”
Overcome the knowledge barrier though, and this investment path tends to be less troublesome and more lucrative than the housing market. Chief among the benefits are generally higher rents than residential investments coupled with stability provided by longer leases – five to 10 years as opposed to the 6-month to 12-month leases typical for an apartment or house.
Tenants of commercial premises also usually pay a property’s outgoings. They are more likely to have more motivation to maintain a property than a residential tenant as it is their business premises, where in most cases they will be attending to customers. For these reasons commercial property is often described as a “set and forget” style investment.
Do not make the mistake however of buying only for yield. Jumping at a high rental return and not considering the full range of fundamentals involved in selecting a good quality commercial investment is the number one error made by the inexperienced said Cal Doggett,
“When people buy for yield that is effectively all they are buying – a yield,” Mr Doggett said. “When the market is going well that’s fantastic but when it’s not going well or your tenant leaves, you’re left underwater.”
Knowledge Is Power
Instead, Mr Doggett said the primary factors on which to make a buying decision are: 1) rental growth and 2) capitalisation and yield compression.
“That’s because these two factors cover so many bases,” he said. “Firstly, if you do number one it covers so much of the necessary due diligence. The second factor takes into account the other important part of due diligence which is understanding how the market will perform in the future and whether it will work with you or against you. There’s always a flavour or the month - right now it’s warehousing, two years ago it was offices in Sydney and four years ago it was retail. You always want to gain an understanding of the market.”
Commercial investors need to be more cashed up than if purchasing residential investments. Properties in this sector are more expensive plus lenders tend to lend only around 70 per cent of the value of commercial and industrial properties. Interest rates are generally higher, too, than for residential real estate. Another expense will be organising the lease. Commercial leases are quite intricate and usually need to be prepared by a solicitor.
Investors should also be aware that while commercial tenancies are longer vacancies are also harder to fill. Should your property become vacant it can be months before a new tenant is found rather than the few weeks it generally takes to rent a home. This is why properties tenanted by solid businesses on long leases are so in demand.
Gain an understanding
Equally imperative is knowing where and why – choosing the right location and understanding exactly how the property will be used. Many components need to be considered with each asset class. Mr Doggett said this qualitative angle is paramount but often overlooked when a buyer is distracted with the many quantitative issues such as valuations and lease negotiations. “Ask why would the tenant want to be in this property and not the one next door or next suburb,” he said. “It’s all about relevance.”
Warehouses for instance are flavour of the month due to the logistics boom driven by online shopping and need to store products for home deliveries. “With these logistics enterprises your tenant will basically have a fleet of different trucks or massive movers,” Mr Doggett said. “What does this tenant want? They want ease of accessibility and be able to drive in and turn around without doing a seven-point turn. It could be ideal to have dual street frontage so they can drive straight through. Vice versa if you’re purchasing a retail premises - delivery by truck may not be most important but access to high traffic areas will be. When it comes to location, if, for instance, you’re doing a last mile delivery, then you need to be within 10km outside the CBD not 70km down the highway.”
“Likewise, a manufacturer may want heavy phase electrical power and gas and turning a truck around will mean nothing to them. It is all about examining and knowing the market.”