Commercial real estate can be a very attractive investment, and the key to success starts with a careful selection process.
Australians are familiar with residential real estate as an investment. But commercial real estate can be a very attractive addition to a portfolio.
One of the most compelling aspects of commercial real estate is the strength of ongoing income. Rental yields (annual rent as a percentage of the market value of the property) are much higher in commercial real estate – typically 4-6% per year, compared to 1-2% for residential real estate.
Leases are also much longer in the commercial sector, typically ranging from 3 to 15 years, which allows for a more predictable flow of rental income, and rents tend to increase each year in line with inflation.
Commercial properties can also appreciate in value, providing investors with the benefit of capital growth. As an indication, this growth is generally equal to or higher than long-term inflation.
For investors, another advantage of commercial real estate is that it is often the tenant who pays most of the expenses of the building. Thus, the burden of costs falls more on the tenant than on the landlord.
As with any investment, it pays to choose wisely. On the business real estate market, four main factors identify a quality property.
Location is key in real estate investing. After all, it’s the one aspect of a property that can’t be changed.
In commercial markets, proximity to transport infrastructure is essential. It’s not just about road and rail transport, it can be about proximity to emerging transport options and new infrastructure such as the light rail network we see in the Sydney Metro.
It is also important that a location be supported by a nearby residential population that has access to local amenities such as dining and retail options, as well as health and wellness services.
Regional markets may offer these qualities, but investors should be aware of the need for a pool of potential local tenants if the property becomes vacant. In this regard, metropolitan locations have strength in numbers.
2. A quality building
Commercial properties are often described according to their grade (Grade A, Grade B, etc.). What determines the grade is a mixture of the physical quality of the building, its location, the floor plan and the quality of the improvements and fittings.
A Grade A property, for example, will have fast lifting speeds, high air quality, an abundance of natural light, and high quality finishes throughout. Tertiary buildings, especially office buildings, are aging well. Thus, a building does not have to be new to be of first quality.
Increasingly, commercial tenants want their staff to work in environmentally friendly buildings. So it makes sense to look at the property’s NABERS score, based on the National Australian Built Environment Rating System, which measures a building’s environmental performance.
3. Value creation opportunities
Recognizing a property that offers investors opportunities to add value works very differently in commercial real estate compared to the residential market.
This is to look for a property that can be expanded in floor space for a tenant who may experience growth. Or, conversely, reduce the floor space to meet the needs of a tenant.
The valuation of a property also requires a proactive approach on the part of the lessor. Being frequently engaged with tenants and having the flexibility to work with their needs will go a long way in maintaining a long-term tenancy.
4. Tenant profile
When it comes to commercial real estate, government agencies and multinational corporations are considered prime tenants. They typically take 5-10 year leases – often much longer than the 3-5 year leases that small and medium sized businesses will take on, and the landlord is much less likely to be constantly chasing overdue rent.
That said, it may also be worth looking for properties that will attract a mix of tenants, including small businesses that are likely to grow and expand their footprint within a building.
As a direct investor, it is possible to find a property that ticks all of these boxes. However, some of the highest quality properties – with a strong location, modern “plug and play” amenities that allow the tenant to move in immediately, and which are likely to attract government or multinational tenants – may come at a price. beyond the reach of individual investors.
A commercial real estate fund – listed or unlisted, offers investors an easier way to add prime properties to their portfolio. It doesn’t take a lot of initial capital to get started, and the fund manager should be well equipped with the skills and resources to identify a quality property.
Receive stories like this in our newsletters.