When people think about investing in property, residential real estate is often what comes to mind.
But commercial property investment is always worth considering, whether you’re looking to diversify your portfolio, create an alternative avenue of cash flow or simply want to take advantage of the benefits of this type of asset.
Below we outline some of the key considerations when investing in commercial property as well as the advantages and disadvantages of this type of investment.
Commercial investment considerations
- There are three commercial property sectors – retail, office and industrial. Each sector has its own risks, rewards, trends and considerations and these must carefully be weighed up before deciding which will be the best choice. Furthermore, there are a multitude of different industries you can be involved in within these sectors, from retail to aged care or warehousing, for example. Each industry will offer different yields and returns for the owner, depending on the performance of that industry. Investors should carefully consider this performance as well as future forecasts when deciding what industry they’d like to be involved in.
- If you’re going to invest in commercial property, you need to understand how this particular market works, how it differs from the residential market and what its drivers are. In addition to population growth, which is the main driver in the residential market, commercial property is also driven by a number of wider economic factors.
- The economy and interest rates – This will impact on consumer spending, demand for services and business performance as well as the landlord’s ability to pay back a loan.
- Demographical trends and patterns can affect commercial property and demand. For instance, with the rise of baby boomers making a sea change, there is now more demand for healthcare services in areas traditionally considered holiday locations. As further examples, our aging population has driven the demand for more aged care facilities while the growing need for childcare services has created more competition and demand for this type of property in Australia.
- Changing consumer habits, often going hand in hand with evolving technologies, have an impact on the commercial property market. Take for instance the rise in online shopping in the past decade which has created demand for more industrial warehouse properties.
- Financial considerations – obtaining finance for a commercial property differs from getting a residential mortgage and can often be more complex. For instance, pricing may not be set in stone and the terms can sometimes be negotiated. Individuals should consider whether a commercial finance structure will suit them and their investment goals.
- It’s different in nature to residential investing and these differences should be understood by investors. For instance in commercial property, tenants are able to make alterations, such as a new fit out in a hairdressing salon. It also differs in terms of who pays what bills. This is discussed further below.
- There is the potential for greater return on investment. In residential investing, yields are often in the 3-5 per cent range while it’s not uncommon to get yields of 6-12 per cent for a commercial property.
- Leases tend be longer – three, five or ten year leases are quite common in commercial property. Ideally, this means the owner won’t have to deal with the costs associated with bringing in new tenants so frequently.
- It may be a way to get into the property market sooner if a would-be investor is struggling to save up for a traditional home deposit. For instance, they may choose to get their foot on the property ladder by purchasing a commercial car park that costs less than a house but still offers solid returns and allows them to build some equity.
- It allows investors to take advantage of booming industries and changing societal trends. Although there may be greater risk, the rewards can also be superior.
- While commercial leases typically last longer than residential leases, it usually takes longer to find a tenant when the property becomes vacant. Investors need to consider whether they’ll be able to cover the costs of holding the property while it is untenanted.
- Commercial real estate is often more sensitive to economic conditions.
- The commercial property market can be volatile and is often less predictable than residential markets.
- It can be more complex to obtain finance for a commercial property. For instance, certain types of commercial property may be considered higher risk to the lender or prove more difficult for them to value. This can mean that financing may be trickier than for residential property in some instances.
- Due to financing requirements, the investor may need a larger deposit to secure approval for a mortgage.