The hidden truths in investing in commercial property

Common myths of commercial investment

An individual carpark will often cost less than a residential home. Picture: Getty

Many of the commercial investment points that concern inexperienced investors are actually more fairy tale than fact.

For example, you can invest in commercial property before purchasing a residential home.

Doing so may actually see investors enjoy a higher income return than that of a residential property,  according to Knight Frank chief economist, Ben Burston.

“The income return, or the margin, of commercial properties, has always been significantly higher than that of residential places,” Mr Burston explained.

“House prices rose so much in 2020 that in some parts of the housing market, income returns are quite low due to a lot of capital growth.

“So those looking for income and instability are now thinking commercial investment might be for them.”

As well, you don’t need to be exceptionally wealthy to be a commercial investor.

Carparks are a prime example of how you can start your commercial investment journey with very few funds in the bank, a buyer on the Gold Coast purchased up a 21sqm lockup garage for just $110,000.

Shane Wall of Stanton Hillier Parker said commercial assets required far lower finances than that of residential properties.

“Buying a small commercial investment generally requires a lower quantum of dollars to get into the market as opposed to buying a residential property,” the sales and leasing company partner said.

Mr Burston added that commercial assets were increasingly attracting investment from private investors along with larger institutional investors.

“The record of strong performance over the past decade has attracted more investors to the sector,” he said.

“We’re seeing private investors and high net worth individuals playing a bigger part in the market than we have previously and I think that this reflects the change in the environment.”

Different types of commercial assets are also available for every price bracket.

In fact, the spectrum of commercial investment possibilities is larger than ever, according to Mr Burston.

“Commercial investment is increasingly diverse across different types of properties,” Mr Burston said.

“We’re seeing investors looking at alternative sectors such as built to rent, data centres, health care and childcare facilities.”

Commercial investment realities

Watch your income grow with a commercial investment’s stable income returns and strong yields. Picture: Getty

Armed with facts, the how to of commercial investing can swiftly become smooth rather than scary for first-time investors.

1. Higher, stable returns

“Commercial property is attractive because of its potential to drive stable income returns over an extended period … and has long term growth potential,” Mr Burston said.

Mr Burston added that on top of this stable income, commercial properties had also achieved strong growth over the past 10 years, thanks largely to the decline in interest rates.

“This is particularly the case for office and industrial assets,” he said.

As well, commercial yields are significantly higher than that of residential, according to Mr Wall.

“Commercial returns at present can achieve between 5%-6% net return and in some cases better,” he said.

“However, depending on the product, residential properties are only achieving around 3%-4%.”

2. Higher upfront capital needed

Banks require more upfront capital than those needed for residential homes, according to Mr Wall.

“You’ll still generally need a 10% deposit, as you would for residential assets, but financiers’ loan-to-value ratio [LVR] – or what they’re willing to loan – isn’t as much as for commercial as it is for residential,” he said.

“An improved LVR for commercial property sits at around 70% with residential sitting at around 80%, or in some cases, up to 90%.

“Banks also generally place more risk weight into loans for particular commercial properties and products.”

3. Longer leases

Commercial leases can last for between one to five years, or more, but vacancies may extend too. Picture: Getty

“Commercial leases generally operate for between one to five years,” Mr Wall explained.

“So, unlike a residential lease, investors don’t have to spend money on releasing the premises every year or preparing lease agreements.”

4. Longer vacancies

The flip side to longer leases is potentially longer vacancies, resulting in extended periods of negative commercial income.

“It’s more challenging to secure a tenant for a commercial asset,” Mr Wall explained.

“You’re generally looking at a lead time of three months to find a tenant.”

Investors purchasing an untenanted property should be particularly wary of this point, Mr Wall added.

“If the property is vacant before purchase, it will be more challenging to secure finance to purchase the premises,” he said.

5. Sensitivity to economic conditions

Commercial assets are always directly affected by overall economic challenges with the pandemic being the most recent example.

The global pandemic has resulted in a severe downturn in some commercial sectors, however, others thrived.

Industrial asset values fared extremely well, thanks largely to a sharp increase in online shopping resulting in the need for more storage space.

Remote workers exiting the CBD for home saw the office sector wobble, but remain fairly stable.

However, pandemic lockdowns resulted in retail floundering, especially in smaller shopping strips. But essential retail assets such as supermarkets and petrol stations have become more attractive to buyers.