10
April
2009
Author:
John Bolton

Residential property investment has been the primary focus for most property investors.  That’s because, when you compare it to commercial property, it is an easily understood form of investment, carries with it a low risk of vacancies and can be more readily saleable in a depressed market.

Commercial property investment has been largely overlooked by many investors; however, this class of property can provide you with much greater levels of return than that from a purely residential investment. An immediate benefit to the owner is that commercial tenants pay for outgoings on the building such as insurance, rates, building Warrant of Fitness fees, repairs and maintenance and often management fees.

As a property investor, if you are looking to diversify your residential investments, then commercial property would be the next logical step. However, we find that residential investors are often wary of entering the commercial property market due in part to their lack of understanding on the driving factors behind commercial investment and perceived risk in reletting a property should it become vacant.

Vacant commercial properties have certainly suffered more than residential in the past when it comes to finding a tenant and prolonged vacancies can occur.

Getting a new tenant signed up can be expensive. Agents’ fees of 13% to 15% of the first years’ rent, and inducements such as a rent holiday and/or help with fit-out costs are often expected.

It is important, therefore, that you have a lower level of borrowing than you would for residential so that you can ride out any prolonged vacancy. With this in mind, banks typically only loan up to 60 percent of a commercial property’s value.

Commercial property investment has always been focused primarily on location.  But of equal importance is the associated tenancy that runs with the property as this provides the source of income for the investment.

The strength of a tenants’ covenant to meet their lease obligations and pay the rent is one of the most important issues in commercial property investment.

Coupled with this, the length of lease term is also paramount. Long-term leases (six to 10 years plus renewals) are very sought-after as they give you, the property investor, a much- reduced risk profile of having an empty building, particularly when a sound tenant covenant is also provided.

Other important factors you should consider include:

  • Location, to ensure the building is well-positioned relative to local service centres, is accessible to main roads or motorway systems and can ideally benefit from visibility and profile to passing traffic.
  • As a landlord, you must ask, could the building be re-let easily and efficiently should the existing tenant vacate?
  • Buildings should ideally be adaptable for a range of alternate uses to meet future tenant requirements. Specialised properties lack this attribute and are therefore more at risk of long-term vacancy if a tenant is lost.
  • Multi-tenancy premises are well-sought-after by investors as they provide a good spread of income and reduced risk associated with having any vacant space compared to a single tenanted building. However, they do carry with them more management issues.

Any property investment should be viewed as a long-term strategy and as a commercial investor you will find that over time you will see rents rise significantly more than a similar residential investment. When economic times are good, rapid increases in rental levels have been seen. With most lease agreements providing for two-yearly rent reviews, this can lead to a significantly higher rent roll and value of the property over time.

The current low-interest-rate environment has meant that positive returns on commercial investment are now being enjoyed, where the costs of borrowing may be say 6.5% whereas the return on the commercial property investment could be around 9.0% to 10%. This additional margin of 3.5% is likely to attract greater interest in commercial property.

Having a long-term view on any property investment is important as there will certainly be some downward fluctuations in value when economic times are hard, as they are now. However, in the long run property investment has historically given some of the best results out of any investment strategy.

John Bolton
Principal and Adviser

The former General Manager at ANZ National Bank, JB has brought his broad depth of experience in the banking industry to Squirrel, which is his own company. JB has directly managed over $30 billion of mortgages and deposits and is a regular commentator on the mortgage market in the press and on TV. JB has a BCA from Victoria University and has undertaken post graduate study at University of London. He’s easy going most of the time, except when it comes to his calculator (he’s pretty neurotic with it).