Tips for investing in commercial property

There are many factors that should play a part in determining the best commercial investment for you.
There are many factors that should play a part in determining the best commercial investment for you.

If you’re considering investing in commercial property, there are a number of key things you need to factor into your decision-making.

Properly researching your own financial situation as well as understanding exactly what you’re purchasing and why you’re purchasing it are crucial if you want to get the best possible returns out of your commercial property in the long-term.

Some of the most common tips given by commercial property agents to first-time investors are to:

  • Know your financials
  • Look for location
  • Check the tenancy profile
  • Look at the lease
  • Investigate future uses

Here’s why those five simple tips are so important as you get started.

Know your financials

Purchasing a commercial property is not the same as buying on the residential market.

Most notably, the amount of money and/or equity you will need to provide upfront is significantly higher for commercial property.

While residential lenders have been known to provide finance to buyers with only a 5% deposit, in commercial property most lenders consider a loan to value ratio of more than 80% as too risky (meaning a 20% deposit is required in order to avoid lenders mortgage insurance).

CBRE NSW senior director Nick Heaton says the tradeoff on the higher initial financial requirement is usually better long-term returns.

“Commercial is more expensive to get in from a cash perspective, but it’s generally higher returning on longer leases, whereas residential is lower returning, easier to get into (and) with a heavier management cost,” Heaton says.

Check the location

As with all real estate assets, there’s just no beating a great location.

But what constitutes a strong location may vary for commercial properties, depending on the property type.

For example, the value of a childcare centre can be significantly higher if it is located very close to schools, while an industrial asset can benefit from having easy access to major transport links and arterials.

“If I was looking to invest in commercial for the first time, it would definitely be about the location,” Ray White Commercial principal Jeff Moxham says.

Location can be everything when it comes to a property’s value.

Look into the tenant

Some agents rate a commercial property’s tenancy profile as the most important aspect when purchasing.

Having a blue-chip tenant such as a major national company or a government agency is considered less risky as they have significant financial backing and are likely to remain in the property for longer.

Purchasing a commercial property with a better-known tenant will increase the price you pay, but there are great properties with excellent tenants to be found at all price points if you do your research.

Moxham advises buyers to do their due diligence on the tenant that is currently occupying the property, to determine how secure they are likely to be in the long-term and reduce your exposure.

“Most importantly it’s about the tenant – who are they, how long have they been in business, is this their first business?” he says.

Look at the lease

A commercial property’s lease is important for buyers to consider, as it outlines important details such as how long the tenant will remain in the property (read: how long before you may need to find a new tenant), whether there are rent increases built into agreement and if the tenant is to pay any of the property’s major outgoings, such as rates, building insurance and land tax.

Leases of 10 years or more, with options to extend, are highly sought-after, while those that also stipulate that the tenant will pay all of the outgoings are considered the gold standard for commercial property leases.

Burgess Rawson childcare specialist Natalie Couper says you should always drill down into the details on the lease to ensure you understand what you’re buying.

“What kind of leases are in place? Does it offer you a good return? Are there fixed increases also within that lease term?” are all key questions you need answer, she says.

The quality of the lease and tenant are important to consider.

Investigate future uses

For some commercial properties, the real value lies not in what its current profile and use is, but in what its future uses might be.

Commercial agents often talk about a property’s “highest and best use”. This refers to the type of property or asset class that would extract the highest value out of a block of land.

For example, a property may currently be a factory or industrial premises, but if zoning allows for townhouses or apartments, it’s likely that it will be worth much more if it is redeveloped for residential uses.

So it pays to investigate the zoning that affects the property you are considering purchasing, and whether there will be opportunities in the future to increase its value by expanding or redeveloping.

“Whatever the service or the business that’s currently operating in that particular location right now, is there potential to have a development opportunity on that parcel of land in the future?” Couper says.

“Is it something that can be of alternative use?”