3 questions to ask when investing in commercial property

Thursday, 14th Sep 2017

investing in commercial propertyWhen investing in commercial property, many investors seek out research and statistics to aid in their decision, only to discover the actual performance of the property is vastly different. Why does this happen and what should investors look for instead?

There are many statistics offered in property industry publications, such as rental yields, vacancy rates, capital growth, incentives, land value, and replacement value. The problem for many investors is they base their purchase decisions on these figures, only to find their commercial property performing very differently down the track.

It’s not that the statistics are necessarily incorrect – but they may often be incomplete or irrelevant if the investor simply takes them at face value. This data is only useful when you’re asking the right questions.

Here are 3 questions every commercial property investor should ask before their next purchase:

  1. Are the statistics relevant to the investment location? Large research houses will generally focus on locations with a higher concentration of property. This means that numbers for the office segment, for example, tend to be from the city centre. Industrial figures may be from one or several key industrial locations.But it’s important to keep in mind that commercial property vacancy rates and rental incomes can vary widely from one suburb to another – even when they are only a few kilometres apart.

    For instance, the Perth office market has rental vacancy rates ranging from 2% to well over 50% in different suburbs. If an investor has the CBD rental vacancy in mind but purchases a suburban office property, they may find this a poor indicator of the property’s performance.

  2. How important is the size of the property? Most investors will have a budget which will likely influence the size of property they consider for purchase. In some cases, a commercial investor will choose to buy several smaller properties instead of one large one because it may seem less risky.This would be a good strategy if the performance of different-sized properties was consistent. Unfortunately, the yield and vacancy of a commercial property can be significantly affected by the property size and grade.

    For example, a smaller property that works well for an owner-occupier may not be suitable for attracting quality, long-term tenants. Generally speaking, rental yields are lower for smaller properties and they typically fall vacant more often, which means less income and greater re-leasing costs over time.

    So is larger always better?

    Having a larger budget won’t necessarily result in a higher return, but it does provide more opportunities to source a quality property. For some, this could mean opting for a different location in order to obtain a higher-quality property. For others, they may decide their best option is to invest with others in a property trust, and own a smaller percentage of a high-performing portfolio instead of owning 100% of a smaller property.

  3. Are there any hidden factors influencing the rental yield? Commercial properties are often advertised with a passing yield percentage. Purely assessing this figure on face value might attract an investor to a property or make them dismiss it straight away.Unlike residential property transactions which are fairly transparent, there can often be factors influencing commercial leasing and sales listings which are not on record.

    For example:

    • A vendor offers to lease back a property at an above-market rate, but a credit search shows the business is in trouble and may not be able to meet the terms of the lease long-term
    • An office has a high rental yield, but there are several incentives built into the lease that will effectively lessen the yield over the next 2 years
    • The yield for a retail property is below market, however it turns out that the supermarket tenancy is bringing on new managers which will have a positive impact on the performance and income of the centre

    Without professional connections, it can be difficult for investors to access all of the relevant information on a property. Not having all the information can turn a commercial investment into a costly exercise, so it’s wise to seek professional advice before making any purchase decisions.

If you want to learn how to get started in commercial property, check out this useful guidebook from our sister company, Mair Property Funds.