Investors shouldn't overlook commercial real estate

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Are you thinking about becoming a property investor this year? If so, do you plan to buy a residential investment or will you also explore commercial real estate opportunities?

Most potential investors would not give commercial property - basically shops, offices and factories or warehouses - a moment's consideration.

The first objection would be that it would cost a lot more than a residential asset. But that is not necessarily so.

off-the-plan

During a search of commercialrealestate.com.au I found a 47sqm office suite in Little Collins Street, in the heart of the Melbourne CBD, for $235,000 plus GST. And a tiny 13sqm office suite in Sussex Street, Sydney, was for sale for a mere $84,000 plus GST. It's unlikely you could find any Melbourne or Sydney CBD apartments at these prices.

Of course, price is only one factor.

The second, and more valid, objection is that the sector is not as straightforward as residential property.

As long as you own a well-maintained house or apartment in an area attractive to tenants, you will rarely have too many problems with a vacant investment generating no rental income.

That is because, generally, demand for rental housing outstrips supply in many areas close to major cities.

Attracting tenants for commercial property is more complex and some commercial real estate can be vacant for a long time.

For example, the Little Collins Street office suite is leased until January 2014 and returns 7% net.

But what will happen after that? According to the Property Council of Australia (propertyoz.com.au), Melbourne has an office vacancy of 6.9%, its highest in six years, so it may take some time to find another tenant.

Generally yields for commercial property are higher than for residential - 6% to 8% compared with 4% to 5% - but so are the risks.

Commercial leases are also generally longer - three to five years compared with six months to a year - but of course you need a tenant who can afford to pay the rent.

The viability of commercial real estate investment is very much tied to the quality of the tenant, so you need to undertake a detailed credit assessment of a prospective tenant or pay someone to do this for you.

Some experienced commercial landlords recommend that, for extra certainty, you try to find a tenant who will give you a bank guarantee to cover the rent.

Looking again at the tiny Sydney CBD office suite, this is leased at $700 a month, returning 7% net.

But vacancies in Sydney are even higher than in Melbourne, at 7.2%, and a space of this size, suitable for only one or two people, might prove hard to relet.

It might be better suited to owner-occupiers. If you have more to invest, for around $400,000 you can find properties in both Sydney and Melbourne that have longer leases with similar returns.

But one disadvantage of commercial property is that there is a smaller choice. And investors will find they can usually borrow only about 80% of the value of the commercial asset as opposed to 95% for residential.

If you do buy a commercial property to either rent out or use for your own business, usually by leasing it back to your business, you can claim tax deductions associated with owning it, such as loan interest and maintenance expenses.

You can also claim depreciation on it and, in some cases, the GST included in the purchase price.

Where to get property investing advice

"Where can I get quality property investment advice?" is a question a lot of our readers ask.

Unlike financial planning, the provision of property investment advice continues to be unregulated in Australia.

All too often seminars purporting to educate people about property investment are little more than vehicles to flog overpriced property to uninformed buyers.

However, Property Investment Professionals of Australia (PIPA) plans to raise the professional standards of property investment advice.

While continuing to lobby the government to regulate the sector, it will also offer formal qualifications to those involved in the property advice industry through its property investor adviser accreditation course (see pipa.asn.au).

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Money's founding editor Pam Walkley stepped down in early 2015 after more than 15 years at the helm. Before that she was at the Australian Financial Review for 11 years, holding several key roles including news editor, chief of staff and property editor. Pam is now a senior writer for Money.