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How to identify a quality commercial property investment

by Ross Lees

Commercial property can be a very attractive investment, and the key to success starts with a careful selection process.

Australians are familiar with residential property as an investment. But commercial property can be a very attractive addition to a portfolio.

One of the most compelling aspects of commercial property is the strength of ongoing income. Rental yields (annual rent as a percentage of the property’s market value) are much higher in commercial real estate – typically 4-6% annually, compared to 1-2% for residential property.

Leases are also far longer in the commercial sector, usually spanning 3-15 years, which makes for a more predictable flow of rental income, and rents tend to be increased annually in line with inflation.

Commercial properties can also rise in value, giving investors the benefit of capital growth. As a guide, this growth is generally at or above inflation over the long term.

For investors, a further plus of commercial property is that it is often the tenant who pays for many of the property’s outgoings. So the burden of cost falls more to the tenant than the landlord.

As with any investment, it pays to choose wisely. In the commercial property market, four main factors can help to identify a quality asset.

1. Location

Location is critical in real estate investing. After all, it is the one aspect of a property that cannot be changed.

In commercial markets, proximity to transport infrastructure is a must-have. This isn’t just about roads and rail transport, it can be proximity to emerging transport options and new infrastructure such as the light rail network we see in metro Sydney.

It’s also important that a location is supported by a nearby residential population, who have access to local amenities such as dining and retail options, and health and wellbeing services.

Regional markets can offer these qualities, however investors need to be mindful of the need for a pool of prospective local tenants if the property becomes vacant. On this score, metropolitan locations have the strength of numbers.

2. A quality building

Commercial properties are often described in terms of their grade (A-grade, B-grade and so on). What determines the grade is a mix of the physical quality of the building, its location, the floorplan and the quality of improvements and fittings.

An A-grade property for instance will have fast lift speeds, high air quality, an abundance of natural light and high quality finishes throughout. Commercial buildings, in particular office blocks, do age well. So a building doesn’t have to be new to be premium grade.

Increasingly, commercial tenants want their staff to work in environmentally-friendly buildings. So it makes sense to look at the property’s NABERS score, based on the National Australian Built Environment Rating System, which measures the environmental performance of a building.

3. Opportunities to create value

Recognising a property that gives investors opportunities to add value works very differently in commercial property compared to the residential market.

It’s about looking for a property where the floorspace can be expanded for a tenant who may be experiencing growth. Or, conversely, shrinking the floorspace to accommodate a tenant’s needs.

Adding value to a property also calls for a pro-active approach by the landlord. Being frequently engaged with tenants and having the flexibility to work with their needs will go a long way towards maintaining a long term tenancy.

4. Tenant profile

When it comes to commercial property, government agencies and multinationals are regarded as blue chip tenants. They typically take out 5-10 year leases – often far longer than the 3-5 year leases that small and medium businesses will sign up for, and the landlord is far less likely to be persistently chasing rent in arrears.

That said, it can also be worth looking for properties that will attract a mix of tenants including smaller businesses that may grow and expand their footprint within a building.

As a direct investor, it is possible to find a property that ticks all these boxes.  However, some of the highest quality properties – with a strong location, modern ‘plug and play’ fit-outs that allow the tenant to settle in immediately, and which are likely to attract government or multinational tenants, can be priced beyond the reach of individual investors.

A commercial property fund – either listed or unlisted, offers a simpler way for investors to add blue chip properties to their portfolio. It doesn’t take a lot of upfront capital to get started, and the fund manager should be well-equipped with the skills and resources needed to identify a quality property.

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