When mum and dad investors consider property, most look no further than the residential market. While homes and apartments may be seen as simpler and safer options, many investors are prepared to defy tradition and set their sights on the commercial sector.
Commercial property differs to residential, but with the right understanding of the key drivers, it need not be more complex.
How does commercial property differ to residential?
Firstly, commercial property attracts GST on the purchase price and the rent received, unlike residential real estate, which remains GST-free on both fronts.
An exception to this may be where the property is acquired with an existing lease in place. In this case, the vendor may be able to treat the sale as a ‘GST exempt sale of a going concern’ (refer www.ato.gov.au).
Commercial properties also usually attract higher yields – seven to eight percent on average, compared to half that for the residential market. But the higher returns are often offset by the bigger risk of longer vacancy periods, which is why choice of property is paramount.*
On the up side, commercial tenants tend to take much longer leases than domestic renters, providing a stable financial footing for your investment.
Another distinction is who pays for property upgrades. In the residential sector, owners foot the bill for maintenance, repairs and improvements, while tenants usually cover the cost of refurbishments to suit their particular enterprise.
The right property
With retail outlets, offices and industrial estates all sitting at the heart of our economy, it can be hard to decide which type of commercial property to invest in.
Many first-time commercial investors are business owners looking to end the rent cycle and acquire an asset at the same time. If you don’t own your own business, a good starting point is to consider the same principles that apply to residential investment. Look for properties in growth sectors in areas with low vacancy rates. A drive around any light industrial estate, CBD or retail strip will quickly reveal the ‘for rent’ signs and give you a pulse check on local supply and demand.
You should also consider local infrastructure, such as transport, and even commercial entities that may be a drawcard for others. In the retail sector, a big brand name with a long-term lease (called an anchor tenant) can be the attraction for smaller operators looking to cash in on the high foot traffic the big name will generate.
Commercial tenants also look for properties with high visibility, easy access and plenty of parking, especially if there is no public transport nearby.
If looking at a light industrial property or office complex in a commercial estate, check it is not in a flood zone. Some commercial complexes are built in low-lying areas at risk of riverine or flash-flooding. Flood cover is not always offered on commercial properties and can be costly when available, so assess the risk thoroughly before you invest.
Commercial property agents will happily help you with the property hunt. Keep in mind their job is to sell, so make sure you do your own homework on values, vacancy rates, average rents and potential tenants for any property put forward.
Another helpful starting point is your mortgage broker. They can help you work out your budget based on your existing loans and financial arrangements and find a loan product suitable for your circumstances.
The right tenants
Attracting the right tenants is the key to successful commercial investment. Concerned by the potential for long vacancy periods, commercial property investors often snap up the first tenant who comes along. Take time to research whether the applicant is in a viable sector with strong demand or a waning one. While you can lock any tenant into a three-year lease, an insolvent business will not be able to pay the rent, no matter how many demands you place on it.
On the other hand, a flourishing business with a strong track record may request a longer term lease in some cases up to 10 years. You may even be able to request a bank guarantee for the term of the lease.
* The information contained in this article does not constitute either financial or taxation advice. We recommend you speak with your financial advisor, and as taxation legislation is complex, you should consult a tax advisor or contact the ATO for further details and expert advice in relation to your personal circumstances.