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Commercial investment: buy the shop

by Ben Power | 13 Nov 2013

Would-be property investors are often more comfortable with the homeliness offered by the residential property market but may do well to broaden their horizons. Commercial property, for its risks, can offer twice the returns and long-term, low-maintenance tenants.

Most retirees still have significant wealth tied up in their homes. But there is another type of property asset, commercial, that may offer value in a retirement portfolio.

Investors tend to understand residential property, but many have a mental block about commercial property, which includes retail, industrial and office.

“Because a lot of people don’t grow up with commercial property they have an initial hesitancy to invest in it,” says Chris Lang, a commercial property advisor. “They feel commercial property is a bit out of their league.”

But there are a number of benefits to commercial property: the yield is higher, the tenant pays most of the upkeep of the property and tenants usually stay longer.

Like most assets, commercial property was hit by the GFC. But it is bouncing back with strong offshore and domestic investor interest in yields. The outlook for commercial property is particularly solid in Sydney and Melbourne.

Canberra and Adelaide are oversupplied, explains Frank Gelber, chief economist and director of economics and property at BIS Shrapnel, while Brisbane and Perth are being hit by falling demand for space from mining companies and an increase in supply of property. “I wouldn’t go near Brisbane and Perth with a bargepole,” he says.

Evaluating options

Across the country, retail is also struggling, Gelber adds. Smaller shopping strips are feeling the pressure, but there are still shopping centres that can be accessed through Real Estate Investment Trusts (REITs) that will do well.

Industrial property is reasonably appealing, with values at good levels and rents stable. “That looks attractive at the moment and is reasonably secure,” Gelber says.

One of commercial property’s main attractions is the strong return. Lang says a rule of thumb for assessing the value of a residential investment is a ‘gross’ (before costs) return of 5 per cent; if you take off rates, insurance and management fees, you’re left with a three to 3.25 per cent ‘net’ (after costs) return.

But net commercial returns can be around 7–8 per cent, depending on the type of commercial property.

“That’s pretty much double what you’re getting for residential property,” Lang says.

Added benefits

The average length of a residential tenant is 15 months, Lang notes; for commercial it is around three years, but often lasts for decades.

Another positive is that tenants generally pay all the outgoings, such as rates and insurance. “Whatever you receive each month, you’re effectively banking,” Lang says.

There are usually better tax benefits through depreciation of things like air conditioning and partitioning, and Lang points out that commercial deductions are around three to four times those of residential property.

Commercial tenants are motivated to look after the property. It’s where they make their living, and they also like to keep their staff happy. One of the downsides of owning residential property is weekend calls to fix faulty plumbing. Commercial tenants are required to meet theses costs under the terms of their leases.

The risks

Of course, there are risks in direct commercial property holdings.

The longer tenancy periods of commercial property can be a double-edged sword. The periods of vacancy are also much longer.

While an apartment might be vacant for around two to four weeks, a small strata office might be vacant for four to six weeks and possibly up to two months, says Lang. That vacancy period, however, “is counterbalanced by higher net return”, he says. 

Seek out the experts

Proper due diligence can help offset risks, so new investors should seek informed advice.

Location and payout are both important. “You have to make sure that when a tenant goes after three, four or five years, you’ve bought in an area that will allow you to readily re-lease the property,” Lang says.

“And it’s no good having the best location but the property being unlettable because it’s badly designed.” 

Finding a property

Commercial property can be accessed through direct holdings, REITs and property syndicates. A small-scale office can be bought for between $350,000 to $800,000, so the purchase price is comparable to a residential investment.

It’s best to borrow conservatively.

“If you borrow 60 per cent or less you can get a non-recourse loan, which means you don’t have to provide personal guarantees,” Lang says.

For retirees looking to diversify away from residential property, shares and cash, commercial property’s strong returns, yield and solid outlook can make it an alternative, as long as investors do their research.