Commercial property offering savvy investors high returns
With commercial property transaction levels soaring this year, API Magazine looks at how the market is shaping up and provides investors with insight into how best to enter the sector.
Growing confidence in the economy and stubbornly low interest rates have seen transactions in the commercial property sector soar this year after a subdued 2020.
For entry-level property investors who do their homework, the commercial sector is presenting itself as a relatively stable alternative to a residential market that has pushed median property prices to record levels throughout Australia.
Throughout 2021, a greater volume of first time buyers have entered the commercial marketplace, as well as experienced investors moving up the risk curve.
Helen Tarrant, commercial property expert and buyer's agent, said the surge into commercial was prompted by COVID-19 lockdowns, as more people looked to put their money into other brick-and-mortar opportunities.
“Obviously residential property has skyrocketed, but many people aren’t really getting the returns and there is a shift now where people are looking for better cash flow,” Ms Tarrant said.
This shift was in significant part being driven by smaller investors who had traditionally looked to the residential market they were familiar with but were now venturing into commercial.
The latest Ray White Now report pointed out that turnover levels have seen improvement across all asset classes, notably industrial assets, which have been best poised to weather the COVID-19 storm, as well as alternative assets such as childcare, service stations and medical facilities.
Vanessa Rader, head of research for Ray White Corporate Commercial, said the influx of money into commercial was due to a range of factors, but said an abundance of money in the marketplace and very low interest rates were central.
“Never before have we had a situation where there has been so many funds chasing assets, the emergence of competitive second tier lenders being a great example,” Ms Rader said.
“Buyers are really just looking for diversification — those who bought into shares are seeing great volatility off the back of COVID-19 and residential investors are grappling with the huge growth in house prices making returns on these assets in many cases sub-two per cent.
“Commercial property seems like a pretty safe option that can offer much greater returns, with many buyers looking for leased investments to give some certainty with yields in the 3 to 6 per cent range.”
Best in class
The boom in commercial is being reflected in corporate agency performance.
Commercial agency JLL, for example, recorded a revenue increase in its capital markets divisions of 158 per cent over the first nine months of 2021, compared with the same period last year, with industrial capital markets’ effort up a staggering 500 per cent.
The retail real estate market has also bounced back, particularly in the second half of the year as shopping mall values reset. JLL’s retail investments business booked a 300 per cent increase in revenue over 2020 levels and office investments lifted 72 per cent by the September quarter.
However, Ray White’s Ms Rader said that while industrial stock was very hot right now, it did not necessarily provide the best returns.
“Retail and office space are presenting the best opportunities for investors, as yields are higher and the risk is going down,” she said.
“With COVID-19 lockdowns now largely under control, and things going back to normal, these risks will only continue to diminish over the next 12 months, providing the best opportunity for investors.”
As a buyers agent, Ms Tarrant said she was recommending new investors in the space focus on purchasing properties valued under $1 million.
“They should choose properties that provide more cashflow, and ones that are simple ‘set and forget’ properties, where there are long-term tenants and you don’t need to think or do too much for the property.
“Specifically, I would aim for a property with around a 6 per cent yield and ideally in a fringe-metro location, outside major CBDs.”
She identified Queensland, and the Brisbane area in particular, as having accelerated considerably, growing by around 15-20 per cent in just the last three months.
“As with residential, this has come as a result of southern buyers seeing the potential in the Queensland market and looking for space there.
Ms Rader said for first-time and emerging commercial investors, traditional assets continue to be attractive, including industrial units, retail strip shops and strata offices in the sub-$1.5 million price range.
“Industrial has been the most in demand given the high growth in warehousing and logistic uses but also due to the overall take-up of industrial stock across the country, so low vacancy makes this look attractive,” she said.
“Conversely, the uncertainties that COVID-19 has brought upon retail and office assets makes it a little riskier, as vacancies are typically up.”
Emerging or alternative assets were still going strong, she pointed out, with medical assets of interest to a lot of first-time buyers.
“Childcare, service stations, fast food are all still being hotly contested albeit in a higher price bracket and stand alone supermarkets are also still in strong demand and will continue to remain so,” she said.
Sydney and Melbourne have to now been identified as the premier locations for commercial investment but rising interstate migration to Queensland and Western Australia has also opened up this market to new buyers seeking more affordable options.
“We are seeing a lot of private buyers not really worried too much about location and more driven by yield and happy to look interstate, which is something we didn't see a lot of before, with first-time buyers especially having tended to purchase in their own area.”
For prospective commercial property investors, Ms Rader said there were seven key factors to consider to ensure an investment becomes a success:
Building approvals - Often assets have been added to and amended over the years, so be certain the property has the adequate approval and its use is permissible under the current zoning.
Hidden problems - While it's hard to see some problems with the asset, ask the questions and ensure you are making an informed decision. Assets like older industrial sheds; what are they made from, will you possibly have an asbestos issue in the future? Are there subterrain tanks on the site which may see you needing to spend money on remediating the land in the future?
Zoning - Just because a tenant is in place doesn’t necessarily mean their business type is permissible under current zoning legislation. Doing your homework on the zoning of your asset is a good exercise not just to understand who and what can occupy your property but to better understand possible highest and best uses of your property in time.
Leases - Commercial leases are far more complex than residential leases so it may be worthwhile to have a professional review the clauses in place for your tenant. What are your rights and obligations as a landlord to the tenant, who pays for what and what reviews or options are in place for rental arrears, sub lease etc.
Research - There are a number of key fundamentals to consider for any asset class; importantly understanding the supply of future competing stock, current occupancy rates and also local statistics like business starts and population growth. There are a number of government sources to collect this information and the council you are investigating will likely have a future plan for their LGA regarding business and development.
Auctions - This method of sale allows vibrant competition between potential buyers and it's very easy to have a sense of FOMO and bid above your budget. Be cautious and set a limit in which you wish to purchase for, consider all the outgoings as well and the income and what yield you are willing to pay.
Exit strategy - It’s worth considering what your exit strategy may be and when you may be interested in disposing of the property. This may be driven by your finances, retirement plan, the length of time remaining on the lease or future potential.