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Many Australians are familiar with the wealth-building potential of a residential property investment. However, commercial property can also be an attractive addition to an investment portfolio. To get started, it’s key to identify assets that align with your investment objectives. Additionally, knowing what you hope to achieve through commercial property investing — regular income, capital gains and/or diversification — is foundational to determining whether or not such a financial outlay is suitable for you.
Let’s get started.
Similar to residential property, the fundamental underpinning of the commercial real estate market ranges from property prices and leasing and vacancy activity to rental rates and the cost and availability of capital. Those intrigued by commercial property investment will want to become more familiar with important terms used to discuss the value of such properties so they can make careful and confident choices in the market.
|Property price||Land value and the cost of the structure underlie the price.|
|Leasing activity||The level of leasing activity in an area indicates how desirable the property is to commercial tenants wishing to rent it.|
|Vacancy rates||Inversely proportional to occupancy rates. Australia has the lowest vacancy rate for industrial and logistics commercial properties, according to CBRE.|
|Rental rates||Refer to the periodic charge for using a space that affects an asset’s yield. For commercial premises, the lease period is typically several years. The rental rate can be a mix of rent, property taxes, insurance premiums and maintenance, depending on the type of net lease.|
|Cost of capital||The minimum return needed to finance capital projects like new construction.|
|Capitalisation rate||A ‘cap rate‘ calculates the expected rate of return on an investment property.|
Determining whether a commercial property investment is appropriate for you involves understanding how to evaluate its market value and what characteristics to look for in the asset class.
As with any investment, it pays to choose wisely. In the commercial property market, four main factors can help to identify a quality asset.
In commercial real estate, the location plays a critical role in price, leasing activity, rental and vacancy rates. A location’s proximity to infrastructure — like the light rail network in metro Sydney or nearby residential areas — attract tenants who desire access to local amenities.
Being familiar with an asset’s regional or local real estate market can be tricky. Still, most commercial property fund managers will have a firm grasp of the market forces at play.
You may have heard of A-grade property. The grade is a mix of the building’s physical qualities, location, floorplan and fit-out. The age of the building isn’t what defines a premium grade; rather, it’s what a quality tenant considers desirable. For example, the property’s NABERS score — based on the National Australian Built Environment Rating System, which measures the environmental performance of a building — is becoming increasingly important to many commercial tenants.
Adding value to a commercial real estate asset requires access to capital and understanding what opportunities have the potential to improve returns. Property fund managers need to be sufficiently engaged with tenants and have the flexibility to change the floorplan, improve the fixtures or attain a higher NABERS score. Such accommodation to tenant needs can go a long way toward maintaining a long-term tenancy.
Investors need to know what drives a tenant to sign a long-term lease. The blue-chip tenants – multinationals and government agencies — will typically sign 5-10 year leases and are responsible and reliable with rent. A commercial property fund offers individual investors access to premium quality properties with sound opportunities to add value for blue-chip tenants. It doesn’t take a lot of upfront capital to start, and the fund manager should be well-equipped with the skills and resources needed to identify a quality property.
With a better idea of the characteristics of a commercial property asset to seek, now let’s turn to the different classifications of commercial property available.
Retail is a broad category, comprising small local shops to larger shopping centres in metro areas that sell consumer goods and services. They can have higher capital expenditures and be more reliant on discretionary spending. Retail leases generally sit in the 3-5 year range.
The blue-chip tenants often need office space with a great location, building and neighbourhood amenities, environmental sustainability and fixed rent increases. To attract a long-term professional tenant to an office, incentives – internet services, fit-outs and free rent – may be necessary. The average lease term for an office property is 2-5 years.
These commercial properties range in use from manufacturing to flex buildings and from 100 to 300,000 square metres in size. These spaces may need to be reconfigured to accommodate machinery and be located near highways, sea ports or airports. Typically, the leases go 3-5 years, but it’s also not uncommon to see longer leases of 10 years. Larger industrial spaces can cost millions to reconfigure, and tenants aren’t likely to move once completed.
These properties’ purposes include hospitality, medical centres, aged care or agriculture. Also, this asset category usually needs operating management to meet regulators’ and insurance requirements and attract the interest of a quality lessee. Often these are built for a single use (e.g. medical centres), and the lease periods can be 5-15 years. Your consideration of investing in commercial property largely hinges on the question of purchasing directly or buying into a fund. Buying direct involves a significant capital outlay and may demand a steady cash flow for adequate property management. By contrast, a property fund offers diversification, potential capital growth and potential regular income.
After gaining more knowledge about the commercial property market and having consulted with your financial adviser on your budget considerations and investment objectives; it’s time to start looking for a suitable investment.
An investor should consider their financial objectives with the assistance of a trusted adviser and then use what they know about the real estate market to evaluate the available options for property investment. Property funds can either be listed on the ASX or an unlisted vehicle. You probably understand listed property funds as they are effectively shares traded on the ASX, but the unlisted property side of things may be more of a mystery.
Unlisted funds or unlisted trusts are not traded or ‘listed’ on the Australian Securities Exchange (ASX) and can be structured in two different ways.
An investor receives units in the property fund for their cash and cannot redeem them until the asset is sold, the proceeds are distributed and the fund is wound up. Often, there is only one commercial premise underlying this fund.
In this structure, an investor invest into the fund at any time and can redeem a part or all of their units in the fund — called a liquidity facility — at regular intervals or other certain times during their involvement with the fund. Unlike closed ended unlisted trusts, the fund often has a portfolio open to new acquisitions, and with no definitive end date.
An unlisted property fund has the potential to provide capital gains and regular distribution from rental income. Additionally, they offer individual investors access to the commercial real estate market at a relatively low entry point.
A commercial property investor should ask for the product disclosure statement (PDS) and be prepared to enquire about the property’s gearing, the fund’s liquidity and professional management experience and expertise. Consult your financial adviser before investing.
Centuria Capital Group (ASX:CNI) has a 25-year track record of specialist investment management in commercial real estate. We relish working with individuals with the desire and ability to stake commercial property across Australia’s real estate markets. Register your interest online.
Disclaimer: All investment strategies and investments involve risk of loss. This content is of a general nature only and does not take into account your particular investment objectives, financial situation or needs. It should not be construed as investment advice and does not constitute any offer or solicitation to offer or recommend any investment product. Centuria recommends you seek independent financial advice from a financial adviser which takes into account your personal financial goals and circumstances.
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