Five Commercial Property Fundamentals For First-time Investors - November 2022
November 16, 2022 / Written by Rich Harvey
Until recently, mum-and-dad property investors would “stick with the knitting” and stay firmly in their residential lane, often buying within the city – even suburb – in which they live.
But that’s changed over the past few years. Buyers looking to build a diverse portfolio have seen how commercial investment can contribute to their goals.
And it’s a sector that’s flourished.
Yet like residential investment, to get the most out of buying commercial you really need to draw on expert knowledge. There are important nuances in commercial that differ from residential. By understanding them and altering your strategies and expectations in response, you can maximise the outcomes.
1. “Barrier to entry” is a myth
As residential investors evolve toward commercial assets, they’re often stopped in their progress convinced the financial barriers to entry will be too great. For example, in most instances, when you buy a commercial property, you’re required to put down a 30 per cent deposit. This can seem ominous to someone more familiar with 10 per cent deposits on residential property.
Alberto said that while this sounds menacing, commercial property is actually very price accessible. He’s seen assets available for between $300,000 and $500,000 which would be an excellent addition to a portfolio. A 30 per cent deposit on this sort of purchase – particularly for those with some equity in their residential portfolio – isn’t difficult muster, and the strong cashflow returns quickly offset the initial outlay.
2. Tenancy is everything
The tenant you secure has a direct impact on all sorts of elements surrounding your commercial asset, from current value to future capital gains.
For example, if a tenant is a start-up company on short lease terms and without a track record of trading success (i.e., they could shut up shop at any time) then they’re a much higher risk compared to an established multi-national tenant.
As such a property leased to that riskier tenant will be worth less than one leased to that second, larger business – even if the two buildings are physically identical.
That is why, in general, vacant commercial property is worth less than a tenanted asset… with one important caveat.
It’s in areas where there’s low supply and high owner-occupier demand for commercial property. In those cases, owners might be willing to ignore yield and buy simply based on their own needs, which can result in a price premium.
3. There are two main ways to assess value
The primary approach to valuing most commercial property is via its yield. The net yield of an asset is the annual rental income after costs divided by the value of the asset.
Say you’re looking at an industrial unit in a complex. Identical units in the complex are achieving 5.5% to 6.0% yield. If you know the net rental income of the property you want to buy, simple algebra says to divide that annual net rent by 5.5% and also by 6.0%, and you’ll have a fair idea of the property’s value range.
The second main approach is to look at properties based on a dollar rate per lettable square metre. If similar properties are selling for between $2000 and $2250 a square metre, then apply that to the one you’re considering and see how it fits.
4. Commercial is unemotional
Even though residential investors will tell you they hold no emotion toward their investment, most form some sort of attachment to the homes they choose to buy.
Not so with commercial. This is a pure numbers game. Alberto said most investors have, in fact, never even inspected the property they purchase. Everything with commercial must be black-and-white around figures and the client mandate.
The upside is that negotiations with selling agents are rarely combative. Both the vendor and the purchaser are aware of where market value sits, and dealings tend to be straightforward.
5. You need an advisor
Commercial investment is far more sophisticated than residential. Any buyer who ventures into the realm without the support of an expert advocate is at major risk of paying too much for a substandard asset. The nuances of commercial are too complex for the average investor to absorb because it’s not just about the price. Unless you work daily in this field and understand the numbers, leases and their context in term of future investment security, bad decisions can be made.
If you have an interest in commercial investment, talk to Alberto so you can benefit from his years of experience and extensive networks across the commercial sector.
To have one of our friendly Buyers' Advocate's contact you, click here to:
call us on 1300 655 615 today.