Diving right in, let us have a look at the what, the why and the how of investing in a commercial property to get a better grasp of the concept.
Commercial real estate is anything other than a house. For example, an apartment building that is five units and greater is considered a commercial real estate. An office building is considered commercial real estate. A shopping centre, A mobile home park, a stores facility even land is considered commercial real estate. Generally, apartments are the easiest to get into, when you are just starting out with your real estate portfolio, because there are so many of them. The other end of the spectrum, the toughest property to add to your portfolio would be class A office buildings. The reason being, firstly there are not so many of them and secondly, the big boys go after them leaving no crumbs for the beginners.
There are three reasons as to why you should consider investing in commercial real estate; Cash flow and the potential to create long term wealth. All it takes is one commercial deal that will change your financial investment portfolio. Just one deal Commercial real estate is a lot less emotional than a residential real estate. Commercial real estate is more of a nuts and bolts business. Where commercial real estate is concerned, you fall in love with the deal and not with the property.
For the third reason, let me share a story, how I started off in commercial real estate. I first got started in real estate by buying and selling single family homes, and I did quite well, it is highly recommended for anyone. It is a great way to start. One day, my mentor sat me down and he asked me a question, would you rather have your twenty single family homes or would you rather have one twenty unit building. I thought about that for a second. Firstly, what I figured was if I only had one twenty unit building instead of twenty single homes, I would only have to make one mortgage payment instead of twenty. Secondly, I would only have to look after tenancy instead of twenty. But the biggest thing has been having just one twenty unit building, I would have just one property manager.
The advantages of commercial real estate generally are;
In residential property, the lease is vastly for 3 to 12 months, after which they are reconsidered or terminated. Where as in commercial properties the leases can vary from 3 to 10 up to 20 years with the right of renewal after that. The rental increase is about 4 percent a year.
Once the landlord purchases the property, other than the structure most of it is covered by the actual tenant. This would work really well for a person looking for investments generating positive cash flow. Because one of the things that strips the cash flow is all of the expenses that you have associated with a property. There is a rental manager fee which one still has to pay with commercial but things like council rates and water, improvements and maintenance of the property in case of a commercial property, a lot of these expenses are taken care of by the tenant. This would make you think that you would have a less rental income considering all the expenses are paid by the tenant.
On the contrary, commercial property provides a higher yield than a residential property. Generally the rent on a residential is about 3 percent to 5 percent. While on a commercial property it is between 5 percent and 8 percent. And depending on the property, a central city office or a warehouse outside of the metro area, the rental would vary.
The things one should consider before investing in a commercial property is;
It is a good asset, good rental income and fewer expenses. It sounds too good to be true and you might wonder then, what is it that hold people back from investing in commercial real estate as opposed to residential real estate. One of the things is, it is easier to get into residential property investment as it is very emotional and can be rented out easily. People who are the tenants of residential property base their decision on likes and dislikes. Where commercial real estate is concerned, the tenants have very specific requirements and is much more aware and educated in the leasing business making it a tad bit difficult to rent the property out. One important fact, which is helpful to be aware of, is that your super fund – the money that self-made ships have stacked up or saved – can’t buy residential properties that you live in but you can buy commercial property that your business is run from. So it is basically the learning curve that holds people back from investing in commercial real estate. Like I stated earlier, commercial real estate is the other end of the investment spectrum.
What is it that you need to learn in order to get your hands into the commercial real estate? This is exactly the same as residential, do your research. Property guides, lease requirements, potential tenants, location, transport et al. You want to make sure that there is demand in the area that you want to buy your property in. This is not very different from what you would do in a residential real estate. It is just that you are looking at a different aspect of the requirements. What makes it easy to do research in residential is that we personally understand the need and requirements of a house. But where commercial real estate is concerned, we get blind-sided by the fact that we are not in the business that our tenants are in and hence it is difficult to know what they need. So, bottom line that people don’t venture into commercial real estate is for the mere fact that it is outside of their comfort zone. Didn’t someone say that to become successful you need to burst the comfort bubble?
Once you do get a tenant however, it is higher yields, bigger returns and obviously they are long term, so you don’t have to worry – like in the residential lease – when it is twelve months and you are out looking for a new tenant. Commercial properties are going concerns and they are reluctant to move. Hence, the lease period is 20 plus with the right of renewal. But it does not end here, you get an added advantage of yearly rent increment as well, this way your incomes does not get stagnated at a certain level, there is a yearly increase.
When you are investing in a commercial property you have to factor in the vacancy period as this period can vary largely based on the property. But then once you do get a lease, then you are looking at a steady income. The rent varies with inflation. The increments varied from 4% to 10%, which is the industry standard. Yes, your capital growth does get diminished as the building depreciated and there is not much land around, but the higher return balances that out.
In conclusion, you will need a larger deposit. Rental yields tend to be higher for commercial properties. You’ve got expenses are paid by the tenant themselves. You’ve got longer leases with increases annually throughout the lease period. You’ve also got potentially longer vacancy rates in order to get someone in, but when they are in it is more consistent for you.
Manish is founder of Business2sell Group of Websites.
Business2Sell.com.au is one of the leading business and franchise for sale listing websites. We work with our business brokers, commercial agents, franchisors and private sellers to help them connect with the right buyers for their opportunities.
With website now functional in Australia, United States, United Kingdom, Canada, New Zealand and South Africa. We have over 18,000 businesses for sale listed, with over 220 Business Broker and Commercial Agent.
I have over 20 years of experience in Web Industry; I have been involved in websites industry since the early years of 1996-97. In my professional career I may have worked for over 10,000+ websites. My Specialty is to build portals or complex online applications.
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