Commercial property investment
If you have a residential investment property you’ll already know some of the advantages and disadvantages of property investment. If you’re new to commercial property investment here’s some background information that might interest you.
Why invest in commercial property?
Commercial property investment is a challenging area of property investment because the commercial property market is so varied and changeable. Like any investment, property investment is intended to achieve a return on the investment. An investment property should bring the investor a regular rental income while the property is being managed, and when the property is sold should return a profit from growth in the value of the asset since it was first bought. The return on stock market investments is similar to the return on property investments but many people prefer to invest in a visible tangible asset like a building rather than in a share portfolio which appears to be a less secure and solid form of asset.
What are the features of commercial property investment?
The types of property available for commercial investment range from a retail shop to a whole shopping mall, from a vehicle repair workshop to a large factory complex, and from a single office space to a whole office block. The range of types and sizes is so wide because in Australia, although home ownership is the norm, it’s the usual practice for businesses to lease the premises they occupy, at least during the early years while a business is being established.
Changes in social and economic conditions in Australia have changed the way that commercial premises are used; as some industries become redundant buildings are recycled for another purpose, for example warehouses are transformed into design studios and old cinemas become gyms. The owners of these buildings have had to adapt their ideas to make the best use of their assets. Technological changes and new working patterns mean that office spaces are used differently and the owner of an office block might find that a tenant who occupied several floors of a the building wants to vacate some of those floors, needing less space because some functions have been automated and staff are working from home for part of the week.
Comparing residential with commercial investment.
Managing a commercial investment property is similar in some ways to managing a residential investment property but also has some unique features.
- Some advantages of commercial property investment. Leases for commercial premises tend to be for longer periods, usually between 3 and 10 years, whereas residential leases are typically for 6 months or one year at most; this means that commercial landlords are not so frequently involved in finding, screening and selecting tenants. Commercial leases often have bank guarantees and provision for regular rent reviews with increases linked to inflation, so the investor in commercial property enjoys longer term security of a lease than the owner of a residential investment property. While a residential tenant can call on the landlord for repairs and maintenance, commercial leases usually require lessees to take responsibility for repairs within their owned leased spaces so the commercial investor is saved the time and cost of dealing with property repairs. To reduce the risk of vacant areas within a building the owner is able to control the balance of occupiers, with a mix of stable long-term lessees and short-term less secure tenants. It is in the interests of a commercial tenant to make sure that their premises are presentable, so a business is less likely than a residential tenant to allow a space become run down. Commercial investment is a good option for an investor who doesn’t want to spend much time managing the day-to-day details of the property.
- Some disadvantages of commercial property investment. An investor in commercial property needs more funds than a residential investor. Commercial premises tend to be larger than residential properties and are on prime sites, so the purchase price of most commercial properties is higher, and more substantial cash deposits (at least 30%) are required to secure a loan to buy a commercial property. Building repair and maintenance costs can be high if there are lifts or air conditioning plants in a commercial building. The commercial property investor also needs funds to sustain the business when premises are vacant and not returning rental income. Commercial property investment therefore suits an investor who has other sources of income and is prepared to hold onto the asset until while the market is weak and profit when the market is strong.
Investing in real estate is a relatively secure and lucrative business prospect. To make the most of an investment in commercial real estate you will need to put in some work to make sure your property maintains its capital value and earns a reliable rental income.
Attracting and keeping tenants
Tenants of commercial real estate are affected by a host of dynamics: swings in the economy, social change, technological developments and many other factors. When your commercial property is untenanted your rental income is reduced immediately, but a vacancy can also have long term effects on your investment plans if it reduces the attractiveness and rental potential of other spaces in your building and slows the growth of your asset’s value. To make the most of your commercial real estate investment it’s important to work on attracting new tenants and retaining your existing good tenants.
Attracting new tenants is a powerful way of controlling your business fortunes. If your property is desirable you will be in a position to select tenants based on their fit with your business plans and strategies. If you own an office block for example, you might prefer to let the whole building to a long-term stable tenant. If you own a parade of shops you might want to have a variety of tenants whose businesses have some synergy – for example a deli, a liquor store and a patisserie.
Retaining your existing good tenants is fundamental: one of the first rules of marketing is that it’s easier to retain a customer than find a new one. You and your tenants have a mutually dependant business relationship: your success as a commercial property investor depends on your tenants’ ability to pay the rent from the proceeds of their business. To foster this relationship each party needs to have some understanding of how the other’s business works, and informal communication has a big role to play in this. It’s good practice to take account of your existing tenants’ needs when selecting new tenants – consider how the new tenant’s activities might conflict with those of your established tenant. An office that has a lot of customer traffic, such as a travel agency, might not be the best business to place next door to a counsellor who needs a quiet working environment. If you own a group of shops you’ll want to avoid having tenants with competing businesses: two fashion shops, one selling children’s clothes and the other selling shoes, might work well but two shops both selling young women’s fashions might not be a comfortable mix. You won’t know how one of your tenants can affect another unless you’ve been talking to your tenants and have a good understanding of the complexities of their businesses.
Keeping ahead of changes in the commercial environment
Businesses operate in a constantly changing environment, and their accommodation needs change as well. If you have invested in commercial real estate it’s essential to be well-informed about changes that might affect you and your tenants.
- Economic changes. The Global Financial Crisis affected most businesses, but more so those that had benefited from a period of affluence. Businesses like fashion retailers, holiday resorts and restaurants flourish when the economy is healthy but suffer when money is tight. If you want to protect your investment from recessions it’s worth having commercial properties that are always needed, such supermarkets and aged care facilities.
- Local changes. Major infrastructure projects such as motorways, public transport terminals or a large new hospital, can have a major effect on the value of your commercial real estate. Even small changes like a variation in free parking times, or moving the local taxi rank, can make a big difference to your tenants’ businesses and have a knock-on effect on your rental income. Some of the effects are difficult to predict – for example, a new shopping centre built near a stagnant business district could either revitalise the area or force the closure of some small retail outlets. To keep abreast of local developments it’s vital to study media reports and to cultivate a relationship with the local council and chamber of commerce: it’s their business to keep you in business.
- Technological change. Most businesses depend heavily on technology. You will maintain the value of your commercial real estate investment if can offer reliable electricity and telecommunications facilities. It might be worth considering installing an electricity generator in your office block so that your tenants aren’t affected by power outages, or if an office in your commercial building is temporarily vacant, a small investment in telephone wiring could make the space more attractive to potential tenants. It’s impossible to keep up with all the developments but it will advance your business if you’re conversant with technology.
Related posts:
- Commercial inspection
- Investment Property Benefits
- How to Value Commercial Property
- Resi Commercial Property Loan
- How to Find the Best Tenant for Your Investment Property
- How to Buy Commercial Property in Your Super Fund
- Commercial Building Inspector
- How to Buy an Investment Property in a Self Managed Superannuation Fund
- How to determine the Best Investment Property
- Investment Property Sales in 2009
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