Residential properties are always front and centre for those looking to invest in real estate, but investors looking to expand their portfolio and maximise their profits should also keep an eye out for commercial property opportunities.
So says one expert, Scott O’Neill from Rethink Investing, who says that while this sector may need more due diligence from your part, the effort could lead to higher cashflows and bigger profits.
Commercial properties are those dwellings that are used for business purposes. Some types of these properties are:
- Office buildings
- Retail properties housing retailers and restaurants
- Industrial buildings that house industrial operations such as manufacturing
- Multifamily properties, covering all forms or residential real estate outside of single family residential dwellings
Commercial vs residential
Commercial properties are, as mentioned, used for businesses, while residential real estate is used as homes. They typically have longer leases compared to residential properties. However, they are also at risk for longer vacancy periods, larger fixes that could be more expensive, and variable lease lengths and conditions.
Residential properties include apartments, villas, townhouses, and houses. On the other hand, commercial investments could be a parking space, office building, or a warehouse – and prices could be cheaper compared to residential properties.
“People often think commercial is a highly expensive thing that you need a lot of money to get into, but the reality is you can find a property in a capital city for $350,000 – sometimes even less”, says O’Neill.
Market drivers of commercial properties
The commercial property market is driven by demand, which may be influenced by various economic factors. Some drivers affecting this sector are:
- The economy. A strong economy may help a commercial property investment to prosper. Strong international, national and local economies could help facilitate a booming commercial market.
- Interest rates. Higher interest rates can slow growth—the cost of money is higher and the rate at which companies can grow is reduced. It also reduces consumer spending. An increased rate could slow down the demand for not only commercial properties but residential real estate as well.
- Infrastructure development. This could increase the demand for commercial properties. Infrastructure development could make areas more accessible, which could make moving warehouse facilities a lot easier.
- Population growth. Locations with stronger population growth may require many services. New suburbs springing up and could mean new shopping centres to service the growing consumer demand.
Risks of commercial properties
Similar to investing in residential properties, commercial investment comes with some risks, such as:
- Longer vacancies. Lease terms for commercial properties are typically longer, which could be advantageous. However, due to the specialised nature of the property type, it also means it may take longer to find a tenant between leases. You need to consider how you will financially manage a prolonged period of vacancy and its carrying costs, should you opt to invest in a commercial property.
- Maintenance and repairs. Larger properties could set you back a small fortune to fix and repair, should it become necessary. Many commercial leases require the tenant to cover the cost of general maintenance, but some expenses will fall back on you. Consider getting building and commercial property insurance, which could protect your property from damage, theft, and other liabilities.
- Changing supply conditions. Increased supply of commercial properties in the same area could create a threat to existing tenancies, as tenants may look to upgrade or expand. Strong supply could also reduce potential yields.
- Commercial investment could be confusing for first-time buyers. Investing in a commercial property needs a lot more research and knowledge compared to residential real estate.
For a first-time buyer, the key is to talk to the right people—not residential property experts, but those who have experience in the commercial property market, explains O’Neill.
Ideal investment structures
Individuals, companies, syndicates of investors and trusts can buy commercial properties. For individuals or groups of less than five, Self-Managed Super Fund (SMSF) may be ideal, as long as no mortgage is required. It could also provide investors with tax benefits.
Things to consider when deciding upon your investment structure are:
- Finance. Commercial property finance is often complex. Because of this, some financiers specialise in this specific field. A commercial mortgage broker could help you find a loan for commercial investment.
According to O’Neill, most lending is the 70-80% range these days. A sign that could mean lenders are looking for more market share in the commercial market. Some loans offer interest rates as low as 3%, which, this year, could be lower for a larger loan.
- Management. A commercial agent usually undertakes the management of a commercial property. He or she operates like a dealmaker and will try to match the property with the right business. The agent could also attract businesses by arranging dals such as rent-free periods or free fit-outs.
- Leasing. The details in the lease could make or break your commercial investment. Some things to consider are:
- Leases can be three, five, or 10 years with an option for renewal
- Rental increases linked to Consumer Price Index (CPI)
- Tenant pays all outgoings such as rates, water, body corporate fees, etc.
- Tenant makes good any physical changes
- Some tenancies may require special council approval. For example: medical treatment facilities and childcare centre
Investing in commercial properties could be overwhelming, especially if you’re an investor who has found their comfort zone in residential real estate. It requires a lot of research, discussing options with professional, and making complex decisions.
Talking to a professional could help you in this chapter of your investing journey. An expert could give me more information about the commercial property market and guide you in making the best decision for your portfolio.
Don’t rush, think long and hard before gambling your money in an investment you’re not 100% set on. After all, it’s better safe than sorry!
Want to learn more about commercial properties? Listen to our YIP Podcast where Your Investment Property magazine editor Sarah Megginson talks to Scott O’Neill, director of Rethink Investor who busts some myths about commercial property investment.