City versus country a commercial property conundrum

‘Country’ or ‘city’ has always been a question posed to commercial property investors. Both options have merit depending on the asset. Commercial property specialist Scott O’Neill assesses the pros and cons for each.

City investing

Pros:

• A greater pool of tenants could mean shorter vacancies. Cities have larger populations, so naturally, there are more businesses floating around in the potential tenant pool. The more tenants you have to choose from, the less leasing risk you have.
• More favourable lending – banks can often lend you a higher LVR (less money down). Banks often prefer to lend more favourably in larger populated areas. For example, if you go to a small regional town with less than 10,000 people, lending maximum ratios could be as low as 50 per cent. In contrast, major regional centres and cities would be around 70 per cent, sometimes even 80 per cent.
• More consistent growth patterns (regional areas are more prone to ups and downs). Cities have diverse economies with many economic layers to them. This may not often be the case for smaller regional towns. We all remember the mining boom and bust period, which is a classic example of what can happen in a single economy town. As a commercial investor, consistency is preferred.

Cons:

• Lower yields. There is a general theme in commercial property; the lower the yield, the lower the perceived risk. As city investments are viewed by the general public as lower risk, so is the yield. Higher yields can mean higher risk and that’s why you would expect a higher yield for single economy towns.
• Often there is more supply of similar properties. If you keep building similar warehouses this means there’s more competing stock for rentals. In country towns, developments are more scarce.
• Higher prices. $2 million in a regional city versus $2 million in a capital city can be two very different assets. Money simply does not stretch as far in the more expensive capital cities compared to regional centres. This can be a disadvantage.

For example, this month there was a sale in Double Bay, Sydney, which was a 356 square metre commercial property. It sold for $21 million. If you spent that same money in a major regional centre, you could acquire a 10,000 square metre shopping centre.

Regional investing

Pros:

• Better dollar for dollar deals – your money stretches further so you can acquire bigger. Similar to the above, you can get more value for money when you purchase in a cheaper regional centre. This can mean higher yields, larger land size, more tenants and bigger well-known tenants. You pay a price to be in the city and this can push many investors to consider larger assets in regional areas.
• Higher yields. As mentioned above, there are higher yields in regional cities due to the applied risk that vacancies might be higher. Also, capital growth might be looked at as a lower probability, which can result in higher yields.

Cons:

• Longer vacancies can be possible due to a smaller pool of tenants.

When it comes to city versus country, I like to take a pragmatic approach. I never dismiss one option over the other because I look at the fundamentals of the property from a local perspective. For example, if you’re buying a shopping centre you need to do the same risk analysis of a five kilometre radius around the property. Just because it’s in the city, as opposed to the country, doesn’t change the risk of the asset. It is still influenced by the radius around it and not the entire city as a whole.

It’s important to look at the merit of each individual investment opportunity, as opposed to getting too attached to investing in one particular area over another. It always comes back to the numbers and how they stack up. If they just don’t then the decision is easy; walk away and keep searching for something that does, wherever that may be.