Why investors should not overlook commercial property

Like most people, I started my own property investment journey in direct residential property investment, and for good reason.

During the early stages of building a property portfolio - what many of us call the “accumulation phase” – investing in residential property can bring valuable benefits that are important for portfolio growth. 

Obviously, one of the main benefits is the ability to accumulate capital and providing you have followed investment fundamentals and purchased a property with the right prospects, history has shown us that residential properties can generate significant capital growth over time.

The important implication of this in the context of portfolio expansion is the ability to leverage this built-up equity (also supported by the gradual reduction in debt as you pay down your loan) to fund further property purchases.

This is one of the key reasons why I believe, at least, for the majority of investors, that residential property is the logical place to start when building a property portfolio.

However, it’s also my opinion that this isn’t necessarily where you want to end.

Why your property strategy should evolve over time

Let me explain.

Your financial goals generally won’t remain static over time.

While many of us start out in property investment with the goal of building capital, as we get further along the investment journey and begin approaching retirement, we will often want to transition towards more of a cashflow focus to supplement or replace wage income.

For some, these priorities may come even earlier but for those with irregular or unpredictable income, such as farmers or the self-employed, supplementary income can play an important role in smoothing out yearly cashflow.

Equally, investors who already have a significant amount of capital allocated to growth-focused assets may want to consider diversifying their strategy earlier to balance their existing portfolio. 

While it is certainly still possible to generate high yields from residential property, this may come at the detriment of capital growth. And once you’ve factored in ongoing expenses and maintenance costs, your net rental yield will be reduced.

An alternative income-producing strategy that investors often overlook is commercial property.

Commercial property as an income-generating strategy

When it comes to commercial assets, their value is largely based on the income return they provide to investors.

Rental yields tend to be higher than residential property (commercial yields can range from 5-7 per cent), which is in part because commercial landlords can pass on their rental outgoings as part of their rental charges to tenants - costs borne by the owner in the residential space.

A more significant reason is because of the longer lease terms generally associated with commercial assets. 

Comparative to the typical 12-month lease on residential properties, it’s not unusual for commercial properties to have an initial lease term of five years or more.

This can be highly beneficial in providing investors with a regular income stream without the need to renegotiate lease agreements and replace tenants on a regular basis.

The implication of this, of course, is a higher risk component should that asset fall vacant.

Comparative to residential assets, commercial properties can stay vacant for months, or even years, while landlords look for a replacement tenant – especially if the property isn’t well suited to modern requirements.

This risk factor is also why commercial property isn’t for everyone.

Why is commercial property overlooked?

So, for those who do have the risk appetite, why is commercial property so often overlooked?

One reason, which has been backed up from the findings of a market survey we conducted at Westbridge Funds Management, is that many property investors simply don’t know enough about this asset class to invest with confidence.

In fact, over half of our survey respondents who said they wouldn’t consider commercial property specified this as an underlying reason.

This awareness gap is perhaps also reflected in the fact that fewer than one in five (16 per cent) of our 700 respondents had exposure to commercial property, despite 70 per cent targeting cashflow as either their main priority or as part of a blended portfolio.

Beyond this, a further 22 per cent of respondents who wouldn’t consider commercial property perceived commercial assets as being too expensive.

Investing in commercial property through a managed fund

When considering commercial property as a direct investment, the reality is that a high-quality asset would likely require an entry price of $5 million or higher.

This presents a significant obstacle for most individual investors, who may also be hesitant to allocate such a large amount of capital to a single asset due to the associated risks.

An alternative is to invest in commercial property through a property fund or syndicated investment structure. This is essentially where you pool money alongside other investors to fund the purchase of an asset (or in some cases, assets).

For larger-scale assets like commercial property, this pooled structure can play a significant role in enabling access to opportunities at a significantly lower capital outlay than investing directly – and with less risk exposure than concentrating all funds into a single asset.

Certainly, for me, these vehicles have played a key role in expanding my own portfolio focus into the commercial and residential development space. 

Of course, syndicated investments – and commercial property in general - certainly aren’t everyone’s cup of tea, and they carry implications and risks of their own that investors need to be aware of.

But it’s important that we know the vehicles available to us when assessing the opportunities to help us meet our ever-evolving investment goals.