I believe that most people would be well-served by investing in various asset classes, including shares and property. I do not believe that any one asset class is superior. They all have their pros and cons which you can balance out in a diversified investment portfolio, which could include commercial property.
Commercial property does have some wonderfully attractive attributes but it’s important to introduce it into your portfolio at the right time (stage of life) and of course, invest in the right asset using the right methodology.
I will explain this in a two-part blog. This first part will provide an introduction to commercial property. The second part will consider how to successfully invest in this asset class.
Attraction to commercial property
Most investors are very familiar with residential property as an investment option. As I have highlighted in this blog many times, residential property is a growth asset because it provides most of its total return in the form of capital growth and proportionately very little income.
One of the main attractions to commercial property is that it typically provides a higher level of income, which may be particularly attractive if you are close to retirement, or you already own a few residential investment properties.
Types of commercial property
Commercial properties can have a varying array of attributes and no two properties are likely to be identical. That said, there are three broad categories of commercial property:
§ Office: An office building is usually a multi-level building that has multiple tenants. These buildings are typically situated in central, well-established locations (CBD or suburban hubs), which adds to their scarcity and tends to drive capital growth.
§ Retail: this includes retail shops in suburban shopping strips, mixed-use premises, and specialised properties such as service stations and restaurants. Because these assets are typically located in high-demand locations, they tend to generate lower rental yields.
§ Industrial: this includes industrial sheds, bulky goods centres (bunnings) and the so on. These assets tend to be located in outer, fringe locations and as such may offer higher rental yields.
How does commercial differ from residential?
Given most people have an understanding of residential property attributes, I thought the best way to introduce commercial property is through making a comparison with residential property.
Rental yield
With regard to rental income, there are two main differences between commercial and residential property.
Firstly, a commercial tenant pays for most of a property’s expenses including rates, insurances, maintenance and so forth. The only exception to this may be land tax. In Victoria, if the lease is covered by the Retail Leases Act 2003, the landlord cannot on-charge the cost of land tax to the tenant. However, as property is regulated by the states, rules may vary from state to state. Suffice to say that given a commercial tenant pays for almost all expenses, it means these investments tend to generate a lot more income than residential properties.
Secondly, rental yields tend to be higher than residential, especially for office and industrial properties. Office rental yields tend to range from 4% to 6% p.a. Industrial rental yields can range from 4% to 9% p.a. This compares favourably to residential houses which typically yield circa 2% p.a. gross (in Melbourne and Sydney), which might be reduced to just over 1% p.a. after all expenses (of course, well-located residential houses more than make up for this with capital growth).
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