5 reasons commercial property is a great investment option
Residential property investment is a great way to generate long-term wealth through capital growth and rental returns. However, there is another asset class proving very resilient in changing economic conditions and continues to be a great long-term investment – commercial property.
Commercial property is a very attractive asset class for the prudent investor for a number of reasons, including long-term stable rental income, higher yields, and strong capital growth. Below we explain 5 potential benefits of investing in commercial property in the current market:
1. Longer Leases
Commercial tenancies are generally longer-term than residential leases.
Commercial tenants tend to be more committed to the property than residential tenants who are more likely to move if their circumstances change. Furthermore, if a commercial tenant has funded a fit-out to the property, they are even more likely to remain long-term and will be reluctant to move.
Commercial property leases are usually for several years with options to extend, meaning investors can be reasonably confident that they will have a regular rental income for a significant period. This allows investors the ability to forecast their income more accurately over the longer term.
Having longer leases in place also adds value to a property as it will minimise any vacancies period which reduces risk for potential buyers.
2. Higher Returns
Commercial property offers considerably higher returns than residential property, making it an attractive investment.
Commercial tenants are often willing to pay higher rent because of their potential to generate profits for a property that is located in a particular position. And paying rent is a tax-deductible expense of doing business.
Commercial leases also often include provisions for set annual rent increases or revenue percentage-based rent, which means the rent is often locked in and increasing for many years to come.
3. Minimal Outgoings
Most commercial leases will include provision that the tenant pays for all the outgoings, including but not limited to council rates, water rates, owners corporation fees, and usage charges for electricity, gas and water. In some cases, the tenant may also pay Land Tax on behalf of the vendor.
Having the tenant pay all outgoings improves the net return (i.e., net yield) for a commercial property.
4. Less Sensitive to Rate Changes
Commercial investment properties generally have stronger cash flow positions which can result in more stability for this asset class.
Typically, when purchasing commercial properties, banks and lenders have lower loan-to-value ratios (LVR) than for residential property. A residential borrower can potentially borrow up to 90-95% of the property’s value (with Lenders Mortgage Insurance as it is over 80%) but for commercial property lenders typically prefer to lend up to around 60-70% of the property value.
This places the investor in a stronger financial position if interest rates rise, due to higher rental yields and stronger cash flow.
5. Capital Growth
Commercial property has the potential for long-term capital appreciation if you buy the right property in the right location.
Well-located and well-presented properties in high-demand and high-growth areas will often benefit from significant price growth. Furthermore, the growth of rental income from long-term leases and annual increases can also contribute to the capital appreciation of commercial property as the yield improves.
Renovations and cosmetic updates can significantly improve a property’s value immediately. Furthermore, the existing tenant may complete and fund a new fit-out for their own purposes, in which case the property’s value can increase considerably without any financial contribution.
Buying the right commercial property in the right location can offer investors considerable benefits, including longer-term leases, higher rental returns, strong cash flow and capital growth. However, the market conditions must be evaluated carefully to ensure quality tenants who desire long terms leases will be attracted to the property during your ownership period.
General Advice Warning- This article does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided regarding your objectives, financial situation and needs.