What to consider when investing in commercial property
With interest rates on the rise in Australia, hunting down high-quality investment opportunities has never been more important.
While the vast majority of investors will always be drawn to residential property, savvy investors understand just how lucrative commercial property investing can be. With investors on the hunt for yield, and with the ongoing lack of supply of quality assets, demand for commercial property continues to be incredibly high.
For investors getting starting in commercial property, it's important to understand that it isn't necessarily more complicated, it's just different to buying a residential property. Here are four things you need to know when getting started in the market.
1. Higher deposits
Most residential property buyers would know that it's very possible to purchase a property with LVRs of up to 90-95%. For commercial property, the reality is that you're looking at an LVR of 60-70% with some banks potentially offering 80% loans.
This is because commercial property is deemed riskier in their eyes and their loan value ratio (LVR is lower). Where residential property can be purchased with as little as $50,000 as a deposit to cover all necessary costs, commercial on the other hand is $75,000-$100,000 as a minimum.
So what's the drawcard? High-quality commercial property has the potential to pay itself off in 10 years, compared to the traditional 30 years a residential property might take.
That means all of that money usually going to the bank, after the debt is paid, then goes straight into your pocket, not to mention the fact that it opens up the possibility to leverage equity and purchase a second, third and fourth property. So the decision to pay a higher deposit in the beginning starts paying dividends immediately afterward.
2. Everything's up for negotiation
When negotiating a residential property, you're normally just looking at the price and a few terms. Commercial property on the other hand allows you to negotiate on just about anything.
When you purchase a commercial property, unlike residential, you are entering into an agreement with the tenant and their business.
Because everything is up for negotiation you will need a seasoned lawyer and negotiator in your corner to make sure you understand what you are signing up for. On the flip side, if you know what you're doing you can use this to your advantage and secure a great deal.
3. Potentially longer vacancies, but, also for longer leases
When a residential tenant signs a lease, they have a number of ways of getting out of it should they choose to leave. For a commercial tenant, the lease is far more stringent and as a result, it is a huge financial commitment for the tenant.
This is because the success of their business is very much at stake and the property will often play a key role in that success. This coupled with commercial property having increased exposure to economic cycles, and, managing the end of a lease - where you may be required to make repairs or undertake maintenance - all mean that you need to be prepared for longer vacancies if a tenant leaves.
The great news is that if you choose a high-quality commercial asset in high-demand, low-supply areas, you can easily mitigate this risk, as these will always be snapped up by tenants. If you purchase a commercial property in a poor location and the building is in disrepair, then of course the vacancy periods will be longer.
Investors need to carefully assess this relatability potential. Such factors include the quality of the building, the location, rent levels and the state of the general market around it.
Getting the due diligence right will help ensure that the property won't stay vacant for long.
4. Not all assets are created equal
Commercial property can be divided into distinct asset classes - office space, retail, and industrial - and each asset type has its own set of risks and rewards, and each follows trends.
It's important to understand the fundamentals of each and their relationship to the current market to make sure you are purchasing a winning commercial asset.
Having an understanding of where each asset class is in its cycle and what will still be a solid investment in 10 years' time will be integral in informing whether you purchase a winning commercial investment over a dud.
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