Commercial assets may deliver a happy new year

For better or worse, there’s no denying the lead-up to Christmas represents the most commercial time of the year.

So, what better than to dive in all the way with a look at what presents 2022 might deliver for those investing in commercial property and offering expert tips on the best way to get started in this sector.

This year has seen unprecedented levels of investment activity across the commercial property market buoyed by a combination of low interest rates, weight of money in the marketplace and the appetite for private investors (many of whom were first-time buyers) seeking to diversify their investment portfolio.

Australian Property Investor Magazine (API) spoke to Ray White Commercial head of research Vanessa Rader about the investment landscape and had her peer into the crystal ball to what the next year might bring.

Meanwhile, commercial buyers agents and founders of Rethink Investing, Scott and Mina O’Neill shared with API their four main strategies to increase commercial investment yields.

Ms Rader said that despite robust results in sales turnover, investment yields have fallen to historic lows for many asset classes, while vacant assets continue to transact and set new benchmarks in capital and land values.

This flurry of investment activity has been countrywide with buyers focused on asset type rather than the adage of location, location, location. For many this has been a successful formula but as we move into 2022 will this trend continue?

“Demand for commercial assets by owner occupiers will remain in the coming year, which suggests investment into the market will continue to be lucrative for investors not afraid to move up the risk curve,” Ms Rader said.

There is an expectation that sales volumes will moderate in 2022 as interest rates rise and the underlying availability of quality stock coming to market eases.

“Many owners continue to ask the question, ‘if I sell, what do I do with the money?’ and with bond rates still low many potential sellers will continue to hold assets,” Ms Rader said.

The changing landscape had made predictions tricky, she said.

“The way in which we interact in commercial real estate has changed from your local shop, working from home impacting our relationship with office space, while the continued increase in online shopping has made demand for warehousing greater than ever before.

“Similarly, the population movements either interstate or regionally have changed the demand fundamentals in some locations, however, this may be a short term shift or a longer term repositioning for some locations.”

The markets to watch

Into 2022 there are a few markets we are worth keeping an eye on and may continue to yield good results, according to Ms Rader:

Industrial: The demand for industrial stock by occupiers is not anticipated to wane over the next few years, which will result in continued high occupancy levels that will pressure rents upwards and keep yields competitive. 

In some markets the vacant land shortage will keep resulting in land values appreciating while the growing costs of construction will be passed on, either by way of increased rents or capital values. Metropolitan markets with good population growth fundamentals as well as major road locations with good access will continue to be in greatest demand.

Set and forget assets: Assets such as service stations, childcare centres, fast food restaurants, and stand-alone supermarkets have been growing in popularity. With tenants taking on all outgoings, this is considered a secure and low risk option that provides a consistent, long-term income stream.

With tenants taking on all outgoings, this is considered a secure and low risk option which provides a consistent, long-term income stream. This year we saw many assets hotly contested via auction and achieve new lows in yield. The demand for these will continue into 2022, however, greater consideration on fundamentals such as location will be the key to ensuring you have a saleable asset upon the end of the lease term

Medical: The medical sector has quietly grown over the past five years. The increased demand for sports and cosmetic medicine has seen more floor space taken up with a medical use. We have seen adaptive reuse of retail assets breathing new life into local strips also.

For many investors these assets have a somewhat future-proof occupier with high standards in regard to hygiene and safety, giving buyers certainty of not only income but upkeep and maintenance.

Queensland and beyond: While this may be a broad prediction, you cannot discount the strong levels of interstate migration which Queensland have been enjoying over the past 18 months.

A growing population fuels the need for all commercial property from retail, office space, childcare, medical etc making it a key area to consider investing in. Western Australia has also seen good levels of population migration but the volatility associated with the mining sector must be considered. This year has seen strong gains for the Perth industrial, retail and residential sectors that should not be dismissed.

Top four do and do nots

According to buyers agent Mina O’Neill, we are seeing rapid capital growth for commercial assets lowering the yields as capital growth outpaces rental growth.

What can be done to increase your yield? Rethink Investing shared their top strategies to increase the yields of the commercial investments:

Don’t purchase at auctions’: More than 70 per cent of the commercial properties that we purchase for our clients are found off-market. Negotiating without the competition normally find during a public sale can lead to savings that can be invested into property improvements.

Don’t underestimate the value of value-adds: Commercial property comes with the terrific advantage of being able to add value through increasing the lease strength and income. For example, if you purchase an asset that has a one-year lease and you can convert that to three-years, this will be valued higher by valuers and other buyers interested in your investment.

Another option is purchasing a property that is under-rented. For example, you might purchase an industrial property that rents out for $91 per square metre but the market rate is $110. If you raise the rent to the market level, then at market review time, you can increase your income by 110/91, or just over 20 per cent. If your income is 20 per cent higher, so should the valuation on the overall asset.

Know the value of rent increases: One way to build capital into a commercial property and to ultimately increase its cash flow is to simply allow the rent to increase over time. Most leases have an annual scheduled increase built into them and as the rent grows and there are a few options for annual rent reviews. You can set them to coincide with the consumer price index, which is the most common approach. A fixed percentage increase is the other main option, with three per cent the most common increase.

Play the long game: Out of hundreds of commercial properties for sale, only a handful are investment grade, i.e., a high-quality asset boasting secure tenants and that will deliver an uninterrupted income stream. One of the trademarks of an investment grade commercial asset is having long-term rental growth and shorter vacancy periods when vacancy issues arise. 

A cheaper retail shop down a side alley might look like an affordable option per square metre but it will be riskier than a perfectly located corner retail shop with greater main street exposure. Buying quality is the most important thing to consider as a first-time investor.