The New Investors Guide to Commercial Property Investment

Introduction: What is a Commercial Property Investment?

Investing in commercial property can be a great way to diversify your investments to gain a solid recurring return on capital, but it is traditionally seen as a space for sophisticated investors and enterprises rather than individuals or new investors. The types of assets that are typically sought after are office buildings, shopping centers, industrial parks and other land or building property that is used for commercial purposes.

Commercial property investments are a type of property purchase intended to be rented or leased for profit. Commercial properties are typically used for offices, shopping and retail centres, hotels,  industrial/warehouses and more. They can be purchased by businesses or individual investors for their own use or as a potential investment opportunity.

Types of Commercial Properties That Can Be Invested in

Commercial property is a great investment because the property can be potentially tenanted by a large number of varying business types. Ensure you understand the risk profile and net yield of any asset before you decide on your final purchase.

Different types of commercial properties include, but are not limited to:

• Retail (strip retail, fuel retail, hospitality, etc.)
• Industrial
• Office Space 
• Childcare / Healthcare
• Hotels
• Warehouses

What Are Some Important Things to Consider Before Investing in a Commercial Property?

It is important to remember that commercial property investment is a long-term investment. When you are looking to invest in commercial property, it is important to consider the following aspects:

• Market Conditions
• Appreciation Potential
• Occupancy Rate
• WALE (weighted average lease expiry)
• Yield
• Risk profile (are there possible steps to de-risk the asset?)
• Landlord/Owner policies or laws

What is Triple Net in Commercial Property Investment?

Triple net is a property lease that includes three types of net costs. These include real estate taxes, insurance, and common area maintenance. A triple net lease is also sometimes called a "full net" or "complete net" because it includes all types of expenses.

What is commercial property law?

The relevant property laws cover any aspect of the use of the property from local council (eg liquor license) to state (eg opening hours) and federal (Eg, stamp duty or land tax). There are variations across all areas, suburbs and states but they cover everything from the use of the building, parking, shared amenities, zoning, and the type of business allowed on the property. 

Commercial property law is a subset of property law that deals specifically with commercial enterprise ownership and transactions. There are many ways to make profits in the commercial real estate market but like all things, it pays to get good advice about the rules and laws that apply to the property you are interested in.

What should be included in commercial property investment?

Before you invest in any commercial property, it is essential to do the necessary research to make sure that you are investing your money wisely… as with any investment but as most people who invest in commercial real estate have some experience with real estate investments - it can be easy to be complacent. Even though it should be obvious, it's worth saying: the commercial property is not the same as residential.

Even though there are similarities (tenants, leases, yields, property management) there is an added level of complexity and understanding this is an important part of the process when investing for the first time or investing in a new type of commercial property. 

Some of the key factors that should be considered before investing in commercial property are:

1. The status of the property - is it new or old?
2. The current rental rates/yields for that area?
3. The occupiers of the property - what kind of companies occupy the space?
4. What is the vacancy rate?
5. What is the asking rent for this space?
6. How much does it cost to maintain this building, including taxes and insurance?

What is the 2% rule in real estate?

The 2% rule is a guideline that has been set for people to buy a property. To avoid buying an overpriced property, it is recommended to calculate the total purchase price of the property and divide it by two. This calculation will show how much you can spend on your house without exceeding your budget. The 2% rule in real estate is not necessarily perfect for everyone, so you should always do your math before purchasing any houses.

The 2% rule is a basic principle that has been used for generations in the production of material goods, but can also be applied to any type of investment. 

Where that is practical in the current market should be considered and adjusted depending on a location, business types but having a starting point to value a property ( like a Price Earning Ratio or Price to Book Ratio) when trying to valeu a home. 

Whatever ratio or number you choose, having a method to quickly assess the price of a property based on its monthly gross income is a good way to measure value and potentially any return on capital. 

What costs are involved in buying commercial property?

In purchasing commercial property, it is important to pay attention to the price, the rental income potential and the costs. A low purchase price may not necessarily be a bargain if it yields little income or is costly to maintain. It is also important to look at how costs change over time, specifically in regards to taxes and insurance.

What is a good yield on commercial property?

The yield is the ratio between the rent and the price of commercial property. The higher the percentage, the better.

Many factors influence commercial property yields in any given location, but in general, a good yield in Australia for residential property is 3-4% depending on the area/city and type of building. 

For commercial properties yields expected can be higher, often in the range of 5-12%, again depending on the location, type of property, and its use. 

Commercial property with a high yield is typically more contested and naturally fetches a higher purchase price by investors given the higher return. Net yield is the profit made by an investment property. It is calculated by deducting all expenses that are related to the property from the rent received.

What is a commercial landlord responsible for?

As a commercial landlord, you are responsible for ensuring that the property meets all the legal requirements set by the government(s).

What about Stamp Duty?

Stamp duty is calculated by multiplying the annual rent by the rate of stamp duty. For example, if the annual rent is $75,000 and the stamp duty rate is 1.5%, then an additional $2,750 would be owed in stamp duty. However, these calculations do not factor in any exemptions or reliefs that may apply to the individual's situation.

When you buy a commercial or any property used to generate income you may be subjected to taxes outside of the typical ones once found in residential property. These may include land, GST, and capital gains tax. You may also find that you are entitled to offset and deduct these differently from how you have managed residential property.  

A conversation with a tax accountant or professional is a great way to start and potentially finding one that specializes in commercial real estate investment would be a good idea.. You always try the ATO website if you’re looking to get started.

Stamp duties and taxes vary by state so a good place to start looking is your relevant state authority. Some information may be found at the following sites: 

NSW
VIC
WA
TAS
ACT
NT

How do you value commercial property?

The method for valuing a commercial property is largely the same as any other asset class (size, age, location) but the key factors in the commercial property include the use of the property which can be legislated, from local, state or federal and impact on the current and future use of that property. 

All these impact the ability to generate an income from the property and add an extra layer of complexity to a commercial property valuation. They do however, provide both predictable ideas of return or even opportunities in the future to change the use (i.e. subdivide, add a liquor license, retail or residential rezoning off commercial areas). 

Final thoughts before your investment

Investing in property is a long-term game, so it's important to do your research before making any final decisions. You should also remember that there are tax implications and potentially hidden costs when it comes to investing in property which you need to take into account along with any legalities. 

As we’ve said, it pays to do your research and seek professional advice before you make your move!