Commercial real estate—worth a look-in?

By Colin Lee
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It could be regarded as a hidden property boom

Investors are always on the lookout for capital growth and higher yields on their investments. Given the cooling phase of the residential market, a possible area to explore might be commercial realty, also as a way to diversify their portfolios—to spread their nest of eggs so to speak.

Advantages of commercial real estate include:
  1. Higher yields (6-11%) compared to residential yields that could go as low as 3%. This means a potential of seven times higher net passive income from commercial property.
  2. Unlike residential property, one can secure longer leases—generally 3-5 years, in some cases up to 10 years. This translates to a “set and forget” cashflow scenario.
  3. Tenant pays for all outgoings, unlike the case of residential properties—more money in your pocket.
  4. Affordable starter option—some commercial properties can be bought for as low as $150,000. One can kickstart into investing and ‘dip your bucket’ into the river of commercial cashflow without forking out hundreds of thousands of dollars.
  5. Could be regarded as a hidden property boom. In some capital cities like Sydney, commercial property growth is much higher than residential. Best case scenario of capital growth with positive cashflow.
  6. Borrowing options made easier. Presently, commercial property investors can get loans of up to 80% of their purchase price at an interest rate of around 5%. Also, low-doc options such as “lease only” loans are available in certain circumstances.
  7. Ability to retire with fewer properties. A prudent investor can reap around $40,000 in net income from just one property with a five-year lease.
Points to note
  • Leases are legally binding and tenants sign for 3-5 years plus options for more.
  • Tenants seek to have an established business to create goodwill as a saleable asset.
  • Seek out areas or hubs with few or no vacancies.
  • Tenants have a vested interest in your property, having invested their money in fit-out or renovations, building insurance, maintenance, land tax and rates.
  • Having invested time and money on the premises, chances are you have good secured tenancy as they build up goodwill and improve your property.
  • The lease is the most important document. Unlike a residential lease which is standard and about four pages long, commercial leases are often 50-60 pages and not standard—generally requiring a solicitor to be drawn up.
Risks and factors to consider

The higher return comes at a higher risk, in the form of higher vacancy potential. Finding a new tenant for a house could take weeks while finding one for a warehouse or shop or office could take a lot longer.

If the sole tenant of your property has to close shop on account of an unforeseen downturn or tough economic conditions, you could face some hard times too. Residential property is more resilient when it comes to economic factors over the long term.

Buying into commercial property is generally much more expensive than residential. This can be mitigated by buying smaller strata title premises.

All said, conduct extensive research and due diligence so that you go in with your eyes open.

 

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