The Pros and Cons of Investing in Commercial Property
The residential market can be hard to break into, particularly if you are trying to get your foot on the first rung of the property ladder.
Is investing in commercial property a viable alternative?
Commercial property can be classified as any non-residential property that operates primarily as a business or a premises where commercial activity takes place.
Types of commercial properties include office space, retail, industrial, medical and hospitality venues.
We will look at the advantages and disadvantages of investing in this type of real estate.
Higher Rental Income and Longer Leases
Commercial properties can return a rental yield of up to 10% (compared with around 3-4% for residential properties).
Commercial leases tend to be longer than residential leases as tenants have a vested interest in staying in the same location for an extended period of time, especially if the premises have been modified to suit the business.
A commercial lease may run from three to ten years, compared with a residential lease of six to 12 months (or even on a month-by-month basis).
As the landlord of a commercial property, you are generally not required to pay council rates, insurance or owner corporation fees – these costs fall to the tenant, as does maintenance arising from general wear and tear.
Any major changes the tenant wishes to make to the property is also at their expense and must be returned to an acceptable condition at the end of the lease (referred to as a ‘make-good’ clause). Keep in mind that as the owner you will need to pay land tax on the property.
Less Emotional Attachment
Dealing with a commercial property can be easier as it’s not your home, and therefore the emotional investment is not as binding. This can make it easier to make a decision on practical and financial terms.
Longer Vacancy Periods
Commercial properties can stay vacant longer between leases – sometimes for years. During this time you as the landlord still need to repay the loan and cover the expenses of the property including maintenance, insurance, rates and utilities.
More Complicated Leases
Commercial leases are not as simple as residential leases. Make good clauses, escalation clauses, fitout costs, rent-free periods and other considerations which affect a business set-up can make negotiations tricky, often involving legal assistance.
Things can also become complicated when insurance claims are made, for example, a public liability claim involving an injury or death on the premises.
More Capital Required Upfront
While commercial properties can cost less than residential, the deposit required is larger –up to 30-40% of the loan. Lenders assess applications for a commercial loan according to a different, more stringent set of criteria than for residential counterparts.
In addition, lenders’ mortgage insurance is not available for business loans, and shorter loan terms are the standard – these are typically around half the time of a home loan for the same amount.
More Impacted by Economic Volatility
An influx of commercial development in the area or changes to infrastructure, access or parking can have a negative impact on the value of your commercial property, making it more difficult to secure reliable and long-standing tenants.
A commercial property that has been vacant for a while will also drop in value as it is perceived as being less desirable.
Costly Maintenance and Upkeep
SPI commercial inspector Martin Fletcher has observed that, ‘shop fronts are generally exposed to street pedestrians and shoppers that can vandalise any of the front elevation surfaces. Keying the glass or graffiti is common to shop fronts’.
‘Laneways to the rear of shops are used for general rubbish dumping, or concealed places for breaking and entering. Damage and leaf litter from neighbouring trees are also a problem’.
‘Stormwater drainage blockages are also a problem as many shops and first floor residences do not have easements’.
If you have weighed up the pros and cons and are ready to dip your toe in the water of commercial real estate investment, seek expert financial advice before making any decisions.
It’s also crucial to engage an independent expert to carry out a building inspection before you sign a lease or purchase a property.
SPI Property Inspections carry out commercial inspections on a wide range of commercial buildings:
Our comprehensive inspection will provide you with an accurate assessment of the condition of the building so that you can make an informed purchase or lease decision. Our reports are prepared in accordance with Australian Standards, with reference to the Victorian Building Authority’s Guide to Standards and Tolerances.
Your report will alert you to any major defects and any maintenance items that need attention or further investigation.
Our inspections cover the following:
These are the elements in the immediate vicinity of the building – fences, surface drainage, retaining walls, driveways, garages, sheds and surrounding trees.
Building Exterior Elements
We check for any signs of settlement or movement outside the building. Elements include the roof,(where access is available), gutters, flashings, valleys, eaves, downpipes, brickwork, weatherboards, paintwork, weepholes, and vents and sills.
Internal Structural Elements
Our interior inspection ceilings, doors, walls, windows, skirting boards, architraves, stairwells and tiling.
Our inspector checks the wet areas with specific focus on elements in the kitchen/kitchenette, bathrooms and toilets, and any showers.
Our inspectors will report on electrical items such as circuit breakers, safety switches and smoke detectors, hot water service and water pressure.
The roof space can reveal if there are any structural or framing issues, missing or broken roof tiles, and the general condition of the insulation and exhaust flues.