Article | Intelligent Investment

Investing in commercial property: The accessible alternative to residential

Now is the perfect time to see why commercial property is shaping up as a viable investment alternative, or addition, to residential property.

June 7, 2023

The image shows a sunlit glass awning outside a shopping centre.

Private investors have an array of choices when it comes to property asset types. While residential receives a healthy majority of mainstream attention, commercial property can also offer investors the opportunity to diversify into an asset with a different risk and reward profile.  

Contrary to general perception, commercial property isn’t solely catered to institutional investors with limitless funds. The sector extends to cover a broad price range of commercial property types from the affordable right through to high end.  

What does this mean for private investors looking to expand or diversify their portfolio with the right assets? Now is the perfect time to see why commercial property is shaping up as a viable investment alternative, or addition, to residential property. 

Where Metropolitan Investments sit in commercial property  

The broader commercial property sector in Australia includes everything from office space, retail, industrial, warehousing, medical, hotels and more. Metropolitan Investments is a CBRE term which categorises commercial property that sits within a specific price range of that sector – at the most accessible end. 

“Metropolitan assets would normally fall into the affordable investment category,” explains Mark Witheriff, CBRE’s Managing Director, Metropolitan Investments, Gold Coast. “These are commercial assets which range from one and a half million dollars all the way up to circa-$20 to $30 million.” 

Whether it’s a small retail strip, a childcare centre, a service station or suburban shopfront, specific pricing for commercial properties under Metropolitan Investments depends on the specific asset type. 

Investor competition in commercial property 

Commercial property in the affordable price range will naturally attract both established and new investors. Despite this competition, Chloe Mason, Associate Director, Capital Markets at CBRE says that it is still highly suitable for entry level investors looking to come into the market. 

"Private family investors, self-managed super funds; people that have typically invested in residential or have a residential portfolio and they want something with a bit more stability are all common investors in commercial property.”  

“We’re looking at both entry level investments and sophisticated high-net-worth investments,” adds Witheriff. "We run a gamut of investor types.” 

Commercial property investor competition can include:  

  • Private investors 
  • Offshore investors 
  • Syndicators – a group of like-minded people come together and invest together 
  • Self-managed super funds (SMSF) 
  • Family offices looking to invest 

Finding top performing commercial properties 

Even with a diversity of commercial property types, there is still one fundamental factor that drives the return on investment across all these assets.  

“Location is what drives it. If you own a shop or an office building in a good location, people will want to be there,” says Witheriff.  

“If you own a shop on a busy road, your ability to attract strong tenants and increase rent will continue. There are so many factors that contribute to the performance of a commercial property, but the location will always be an integral part of it.”  

Here is closer look at the performance factors comparing residential and commercial property: 

Performance factors for residential property: 

  • Capital growth 
  • Rental demand and yield  
  • Location 
  • Type of property (I.e. house, unit, townhouse) 
  • Quality and age of property 
  • Property features 

Performance factors for commercial property: 

  • Building quality and age 
  • Building’s future ongoing maintenance costs and whether investors can pass that cost onto the tenant or landlord 
  • Building’s potential use  
  • Building's amenities  
  • Rent review structure (I.e. if it is a CPI or fixed percentage increases, or is there a market review which could increase or decrease the income) 
  • Ability to upgrade tenants which can drive rent growth over time 
  • Strength and stability of the tenant in the property (I.e. how long they’ve been in the building and tenant covenant) 
  • Demographics of those using the building over the long term 

From this comparison, a critical point to consider when investing in commercial property is the dynamic nature of each type. Owning a property in a major city like Sydney can potentially mean wider foot traffic, audience and marketplace, but this doesn’t suggest that a similar property in a regional centre is better or worse. 

“It just means the property has less competition,” explains Witheriff.  

“A commercial investment be it in a capital city or a regional market has to be viewed on its own merits. Location, tenant profile, lease covenant and price point overarched with competition from other properties will always need to be assessed when reviewing a potential acquisition.” 

“Each one is different, and the dynamics are different. It really comes down to the risk profile of the location and of the property.” 

Return on investment: commercial vs residential 

There are two advantages of investing in commercial property:  

  1. Return on a commercial property is predominantly higher than residential 
  2. The lease documentation is well structured with the ability to dictate rent reviews and conditions of occupancy, and these can also include the ability to add in make good provisions at the end of the lease 

“Traditionally, residential yields are about 3.5% to 4%, where commercial property yields vary but on average quality investments should return around 6% to 7%. Traditionally, they would also have relatively low risk profiles,” says Witheriff. 

“The opportunity for growth in rent is significantly higher and it’s usually fixed and not necessarily market reliant. And for investors looking for a longer-term commitment, it can be seen as a safer investment.  

“You could get anywhere between sub 5% yields for a childcare centre or a retail strip investment paying between 7% to 7.5% ROI,” adds Mason. 

“The shopping centre I have on the market at the moment is delivering anywhere between 7.5% to 8% yields. It’s a larger asset to manage and you’ve got anchor tenants, but also the risk of smaller tenants exiting. Higher risk often means higher returns.” 

While maintenance costs are commonly the responsibility of the owner/investor for residential properties, commercial property maintenance costs can be passed on to tenants if the building is a tenanted investment and not a development site.  

“You can sit back, take passive income; it can be managed for you. There are a lot of different factors for each asset class, but it will fundamentally come down to the investors' appetite for risk, and the budget they have allowed.”  

What commercial property attracts tenancy 

CBRE market insights indicate that the strong performers in commercial property within this specific price range are:  

  • Childcare centres 
  • Medical centres 
  • Strip retail  
  • Boutique offices 

Tenant potential is critical when investing in either a residential or commercial property. With Australia’s residential sector currently experiencing significant supply constraints, a surplus of tenants means securing tenancy for a residential investment is relatively easy.  

 Finding tenants for commercial properties depends on the asset class. Traditionally, tenants will look for “an incentive” to be enticed to new space. This would normally take the form of a percentage of the annual rental, with incentives varying from market to market. What the tenant is in effect asking for is assistance to move into a new space by covering some of the set-up costs such as office fitout, signage and some rent-free period. 

Tenancy stability is ultimately one of the biggest advantages of commercial property.  

Mason highlights one of her current shopping centre properties with tenants on a 12-year lease with five-year options after that as the perfect example of tenant stability. 

“Residential can be a little less sophisticated in terms of its tenant profile. Traditionally, properties are rented to families or individuals while their lease covenants will depend on their personal circumstances at any point in time.  

“The documentation is generally more simplistic and there are several government requirements that need to be met for tenant protection. But the positive always remains that residential has a significant place in the market and can be readily re-let or sold should the investors circumstances change,” she says.  

The key takeaway: The right commercial property can continue to demonstrate its investment strengths if it is in a sought-after location. 

Important considerations for commercial property investors 

  • Banks will want a higher equity stake from owners of commercial property for better loan security in comparison to residential investments 
  • Investors need to understand the market dynamics and work with their tenants prior to the lease expiry so that they’re aware of whether the tenant will be remaining in the property or vacating at the end of the lease term. This allows the landlord the ability to forward plan and commence any marketing prior to the lease termination  
  • While the ROI is higher for commercial properties, more due diligence is required by investors 
  • There could be a lot of different demands compared to residential investments, however, this is due to the tenant longevity  
  • Strong competition for prime Metropolitan commercial properties means that new or private investors can face greater competition from a broader marketplace

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