Investing in Commercial Property?

Investing in Commercial Property?

We’ve all got our heads around Residential Property Investment, but ever considered Commercial?

Probably not. Unless you’ve opened your own business, or had to search for a premises, chances are you’ve never opened Real Commercial or similar apps in your life.

But, is it potentially a viable investment? And how do you go about it?

We’ll tackle some of the key problems and details later, but here is a quick run down on Commercial Property Investment.

Capital Growth vs Cash Flow

One of the biggest key differences between a residential property as an investment, and a commercial, is the general rule of thumb is Capital Growth – Residential, and Cash Flow – Commercial.

These factors can differ on location, quality of the buildings etc, but you’ll find most offerings from major Capital Cities will follow this rule of thumb. Analyse the return on a residential property at the same price point of the commercial.

In Sydney, 3% or 4% rental return per annum on a residential property is standard. Offices and retail in Sydney can achieve 7-9%, whereas industrial units can fetch up to 10-12% per annum.

Expenses

As a residential investor, you will have many expenses to look out for. These include Council Rates, Water rates, repairs and maintenance. Factor in insurance, property management fees, and other, and you’ve got a substantially growing list.

Up to 30% of the rent can go to expenses.

In Commercial Property, this can be vastly different. Now, a tenant will cover the majority of expenses, (outgoings), including council rates, insurance, management fees, which can equate to around 5%.

Once again, these numbers can be different for a number of factors.

Leases

Sick of 6 month or 12 months leases? We are too. Thankfully, the usual lease length of a commercial property can be 3-5 years long. I’ve seen some come back at 10 years long, and government contracts for 20-30 years. Don’t expect the latter too, but its out there.

On the flip side, it does take longer to lease out, but we’ll talk about that next.

Buy in

Commercial property is actually cheaper on face value than residential. Where you may buy a home for $900,000, you could also pick up a commercial property for $300,000-$600,000, industrial, office or retail.

Your deposit can be as high as 30% however, to secure approval for a commercial mortgage. We’ve seen cases of people leveraging their current home to gain a better rate, however that’s a case by case scenario.

GST

Yes, you pay GST when buying a commercial property, so allow for 10% for that one. As an investor however, you can claim that all back as an ‘input tax credit’ against GST charged on the property’s rent.

Chat to your accountant about that one.

Too good to be true? Well, yes, sort of.

There’s a good reason why there are such high returns, and the purchase prices of commercial are often seemingly lower. This is because it is a much higher risk.

Firstly, commercial supply can cause astronomical problems on an investor. Supply doesn’t move nearly as much as it does for residential, therefore with lots of new supply, comes much more competition, and not much to fill the gap.

Now, while infrastructure can aid you, it can also damage you immensely. It can lure tenants away from older premises, as the demand is much lower.

On the same theme of supply and demand, once your property becomes vacant, it can often take a long time to rent back out. You’ll need to cover all the expenses during this period. On the plus side, it’s worth noting your leases are generally more long term, 3-5 years on average.

Finally, another risk is economic power in a region, industry, company etc. When the power is shifted from a certain area, whether it be a change to supply and demand in the industry, or a particular region, there are mass changes to the property market, vastly affecting your bottom line. It pays to monitor these and to make sure. If the economy is strong, you’ll have less issues, but if it falls, and it can like the drop of a hat, it will affect you.

Should I do it?

I can’t answer that question. Not only because I don’t want to get sued, but because everyone’s portfolio is different. For some, commercial property makes sense, but on the flip side, for some, capital growth is more important, as is security.

Consult a professional, a financial planner, before making such a decision, as you’d want to be far more calculated in determining whether you purchase a commercial investment.

Author

Michael Turner is a Property Development and Analytics Specialist operating in Sydney’s Growth Centres and corridors. He is a Director of YPI, along with several roles at property development firms and agencies. He can often be heard on various radio mediums talking about Football and Property. You can find him on Twitter @mturnerypi or email him directly at m.turner@youngpropertyinvestor.com

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