The pros and cons of commercial property investment

The pros and cons of commercial property investment

As with any investment, there are always benefits and risks that you should weigh up before making any commercial property investment decisions. A financial adviser can always help in working through what these are and how they may suit your risk profile. In short, these are some of the pros and cons of commercial property investment.

Benefits of commercial property investment

Potentially strong returnsCombination of the potential for capital gain and income.
Historical performanceOver the past 20 years Australian listed property has had higher returns compared to many other asset classes1.
Income stabilityCommercial properties that have longer leases lock in tenants for longer periods
Tax benefitsSubstantial depreciation allowances in the form of tax deferred distributions
DiversificationCommercial property can assist with diversifying investments across different asset classes. In addition, there are lots of different types of properties to diversify into
Capital gainsCommercial property investment has the potential for capital gains if the property value increases
Longer lease termsUsually leases are between 3-15 years as opposed to six months for residential property. This provides longer income certainty than shorter lease terms.
Reduced overhead costsUnlike a residential tenant, the commercial property tenants sometimes pay for all the repairs, maintenance, property management fees and rates in the building.
Net distribution returnsThat will often compare favourably to residential property investments (after factoring in gearing).
Potential to add valueAs with residential property, it is possible to improve the value of a commercial property investment, however, it will require planning and incur costs.

Risks of commercial property investment

Stock market volatilityIf you are investing in commercial real estate via a REIT, the fund can be influenced by market sentiment as well as the underlying value of the assets.
Valuation riskCommercial property investment has the potential for capital losses if the property value decreases.
Liquidity of the property fundDifferent types of investment have different liquidity levels:

  • REITs are considered highly liquid as they are traded on the ASX
  • a closed ended unlisted property fund will generally have no liquidity until the end of a fixed term
  • an open-ended unlisted property fund will have liquidity events and may have quarterly or monthly limited liquidity available. This could be suspended at times where the manager is not able to satisfy withdrawal requests within the timeframes specified
  • a direct property investment allows an investor to sell when the time suits them, assuming there is a market for the property.
  • Fund values can also be impacted by a fall in fund revenue, unexpected capital expenditure, force majeure and changes in interest rates
COVID-19 risksAny failure of a tenant to pay rent, rent abatements or a reduction in demand will impact the Fund’s revenue. A downturn in the property or share market (REITS) will have an adverse impact on the value of the fund and return to investors. Existing risks may also be affected or heightened.

Other things to consider

Gearing of the propertyCommercial investments typically have associated borrowings from a bank, which enables access to higher value assets, and potentially higher value returns. The gearing level, which reflects how much debt is being borrowed is important. Gearing can magnify gains or losses. Centuria’s gearing of its property assets is typically between 35%-45% of the initial value of the property, which is relatively conservative.

1. Source: Lonsec Investment Consulting Australian Investors Chart Pack – June 2020. Past performance is not a reliable indicator of future performance.

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