Commercial property investments make up a huge part of the property industry in Australia. These typically are much larger and more expensive investments than residential property, and are generally focused more on strong cash-flow rather than capital growth. Whilst often thought of as a riskier form of investments, commercial property investments actually have a huge number of unique benefits over residential property. Commercial property investments are frequently structured through syndicates and Real Estate Investment Trusts due to their higher costs, unique financing needs and more complex legal contracts – however many are owned individually.
“Successful commercial property investment requires an understanding of the complex market factors at work, unique financing requirements, property management options, leasing arrangements and a good grasp of the potential risks.”Mike Yardney, commercial property investor and commentator
Whilst commercial property investments are typically higher yielding than residential, they might not have as much capital growth and this industry is not without it’s risks. Commercial Property investments have a higher risk exposure to general economic conditions – for example Australian commercial property investment yields have slumped to 9 year lows (currently averaging around 8.3% p.a.) as the retail and office-space sectors have been hit hard by the effect of the COVID-19 virus and lock downs. Does that mean it might be a good time to pick up distressed commercial properties?
This article will explore commercial property investments in Australia, and ultimately seek to answer the question of whether I will personally invest in Commercial Real Estate as a part of my ‘Financial Independence’ portfolio.
Introduction to commercial property
Commercial property is the name given to pretty much all non-residential real estate in Australia – property which is used for commercial purposes. Sometimes commercial property is further subdivided into Industrial, Agricultural, Resource (mining) and Commercial property categories (where commercial reflects Hotels, Retail, Office Space and the like), but broadly speaking, it generally refers to all non residential property.
Most businesses prefer to lease their premises because of the large amount of capital owning the property would tie up. Leasing;
- Simplifies their business model and cash flows
- Frees up significant capital which they can invest into their core business model
- Lowers overall risk for the business
- Allows for tailored occupancy – long term contracts can be signed to provide security, or shorter terms for flexibility as the business grows
Commercial property can make a fantastic investment for institutions, investment funds and high net worth individuals looking to diversify their property portfolios away from residential property. However, they are not without their risks – the performance of commercial properties are generally linked with broad economic performance, as well as being closely tied to the performance of their type of tenant or ‘niche’. This requires a much higher level of investor expertise, and legal oversight in contractual agreements.
Broadly speaking, Commercial property is driven by yield rather than capital growth. Which means you are investing for cash flow now, rather than capital appreciation for later. Commercial property in Australia typically yields between 5 to 10% (Net) p.a. which is higher than what you can achieve in residential property where the average is around 4% yield, but there may be less upside for gearing and capital appreciation on commercial properties. This figure will of course fluctuate with the performance of the economy (a worsening economy typically means higher defaults and increased vacancies for commercial tenants), and latest estimates have commercial yields averaging around 8% p.a.
The Sydney CBD commercial property market is considered one of the strongest commercial property markets in Australia, closely followed by Melbourne CBD. Globally these markets are considered quite expensive – however unlike residential property where high prices can mean terrible yields, commercial property investors are usually rewarded accordingly with higher cash-flow for more expensive commercial properties.
“The industrial property market is less volatile than the other commercial property markets. It tends to increase less during economic upswings, and decrease less during downturns – meaning investing in industrial property is considered fairly stable.”Marcus Sohlberg, Asian Property HQ
Capital cities usually have strong commercial properties in the Office Space and Retail sectors, whilst Industrial properties typically have the highest yield per square meter. Just like residential properties, commercial properties can also benefit from property improvements and renovations to raise their values, and can have generous depreciation schedules written for them for tax efficiency.
Types of Commercial property in Australia
There are loads of different types of commercial property investments in Australia. With hundreds of thousands of restaurants, thousands of large shopping centers and office buildings, there is no shortage of commercial real estate to invest in. Broadly speaking, examples in Australia of commercial (commercial, agricultural and industrial) properties include;
- Hotels and resorts
- Restaurants Pubs and clubs
- Sporting, Parks and Recreation facilities (i.e. ovals, pitches, fields, swimming centers, stadiums and arenas)
- Performance or cinema theaters
- Medical facilities
- Agricultural property
- Mining or resource properties – for example as timber plantations and forests
- Industrial facilities – Manufacturing factories and production plants
- Construction facilities
- Retail property (such as shopping centers)
- Office space and work studios
- Logistics facilities and Warehouses
- Parking facilities (believe it or not, there are car parking spaces in Sydney going for nearly a thousand dollars per month!)
- Storage facilities
- Tourism facilities
- Transport infrastructure – Airports, Ports, Railways, Bridges and Toll roads
Of course, when considering specific zoning regulations, there are some important distinctions between commercial, industrial and agricultural lands and their uses which you should know about. More about this later, but this can be a major sticking point for the profitability and valuation of commercial properties.
Benefits of Commercial property investments in Australia
Commercial property investments in Australia come with some unique advantages over other types of property
“Some of the advantages of investing in commercial property include lease terms of three to five and up to 10 years, depending on the type of property you buy, rental increases written into the lease, and tenants being responsible for most outgoings”Mark Wizel. CBRE Melbourne retail director, Interview on CommercialRealEstate.com.au
Commercial property investment advantages include;
- Higher cash-flow and rental returns than other forms of property
- Strong returns over the long term
- Fairly stable rental income
- Can negotiate longer tenancy contracts – most range between 3 to 10 years: Lessees generally have vested business interest to stay put
- Benefit from your specialist experience in a particular industry
- Typically financed using Interest only loans to maximise your cash-flow
- Leases typically involve ‘rent reviews’ at yearly interviews in the contract to increase the rent in line with market conditions or CPI figures.
- Lessees typically cover all costs of the property – such rates, body corporate fees, insurance and utilities
- Lessees will usually take much better care of the facility since it is directly related to their business income
- Lessees typically cover costs of maintenance of facilities
- Once contracts are set up, they are fairly well automated and Lessees don’t need much management at all
- Generally lower volatility and more stable price.
Negatives of Commercial property investments in Australia
Commercial property investmentsin Australia are not all sunshine and happiness though, and there are a few things you need to consider;
- Generally weaker capital growth prospects (Although not necessarily!)
- Can be higher risk – you need to understand your potential Lessees business, industry and wider economic cycle better
- Need more capital to invest – due to the additional risks lenders typically require higher deposits so you have more equity in the deal to ensure they don’t lose their capital – typically only around 60 to 70 % LVR.
- Quality commercial property investments are also typically quite expensive – often starting in the millions of dollars and costing many times more what a similar sized residential apartment would cost.
- Lessees usually have special needs so leases will be more complex and usually need to be prepared by legal professionals
- More exposure to wider economic influences – For example COVID-19 has negatively affected commercial property
- Interest rates on commercial property loans are typically higher than residential property loans
- Vacancies on commercial properties can typically be much longer than vacancies on residential properties.
- Can be a fairly ‘non-liquid’ asset which ties up significant capital
- Can be difficult to value and have high transaction costs
- Fluctuation of interest rates can have a major influence on cash-flow, profitability and property prices.
- Commercial property value and demand is highly sensitive to competing developments or infrastructure being built.
- Lack of research, knowledge or data for commercial properties can make it difficult to get the full picture
- Subject to the Goods and Services Tax (GST) – must factor in a 10% GST tax for your cash-flows (although you can claim input tax credits)
- Lack of liquidity – commercial properties might take many months or more to sell (compared to weeks with residential properties)
Risks of Commercial property in Australia
There are several risks to do with commercial property in Australia;
- Finance risks – Typically interest only loans which are renegotiated periodically, and a lender may decide to terminate or not renew your contract for a number of reasons, forcing you to sell the property. Also, these interest rates might fluctuate – if they rise this could seriously drain your cash-flow.
- Tenancy risks – If your tenant goes broke or leaves, it might be a substantial period of time before you can vacate or replace them – which might involve lost rent and also expenditure in removing client property. However, in some contracts you are able to seize property or equipment left in your facility to liquidate (sell) it. For most commercial properties, the valuation of the property is highly correlated to the quality of the tenant and the remaining time under contract – losing a great tenant could mean a sharp drop in the commercial properties value.
- Cash Flow risks – Commercial properties generally have higher overall cash flows, and for the two reasons above combined this might mean you need to hold significant buffers to mitigate cash flow risks. Larger commercial properties can be extremely expensive to hold and service when they are not tenanted.
- Insurance / legal risks – Your building might be subject to similar insurance risks as residential properties – crime, accidents, flood, fires and other natural disasters. Although often tenants will be responsible for organizing their own insurances, you might be liable as the property owner.
- Environmental risks – if you are leasing industrial facilities, you may be liable for any environmental damage or pollution caused by your clients such as soil contamination.
- Property risks – you will want to get thorough property inspections, just like you would for pest and building in residential real estate. It is estimated that the majority of residential towers in New South Wales have major structural defects, and this cost is passed on from developers and builders to individual investors through strata, repair and legal costs when these are properly discovered. Commercial properties are just as at risk, if not more, and require thorough due diligence before signing deals.
- Infrastructure risks – if new, competing infrastructure is built this can lower the value of your commercial property. However, this is a double edged sword, and often new infrastructure can help bring more buisness which raises the value.
Where do commercial property investments in Australia fit in your portfolio?
Commercial property investments are a great way to gain exposure to certain parts of the economy. Of course, I talk a lot about the benefits of index investing where we spread our risk evenly across a broad number of businesses and sectors using an index tracking Exchange Traded Fund. However, some investors prefer the opposite and love the ability to concentrate their portfolio by owning one (or more) certain stocks.
For example if you were a staunch believer in tech stocks, you could invest in a tech giant like Amazon. Similarly, when it comes to property, if you believed in the rising digital economy and the growth of online shopping, you could also invest in a commercial warehouse or online shopping distribution center.
For a first foray into a commercial property holding, something small like a small storage facility, lock-up or studio could make for a great start
“Smaller industrial properties often fetch lower prices, compared to retail or office property located in prime areas in the big cities. Thus, investors with less financial backing could have this as an option.“Marcus Sohlberg, Asian Property HQ
Commercial properties are also usually thought of as a ‘moderately geared’ asset, since lenders typically will only finance around two thirds of the deal. For most people then, this means a commercial property investment is usually a more advanced consideration. Commercial properties usually fit into an established portfolio of residential property and a diverse portfolio of shares – once you have more capital and are seeking diversification or specific market exposure.
“A first commercial investment involves many different variables, and it’s important to understand these associated factors because getting the first one right is imperative to building momentum and allowing the investment journey to be an enjoyable one,” he says.Rick Silberman, Savills Retail Investment Director – on weighing up the risks vs securities of commercial property
For this reason, commercial properties generally aren’t recommended for beginner investors who might do better to establish a core portfolio holding of index funds first, and also perhaps explore a moderately geared position in a moderately priced residential property investment like a freestanding family home.
Can foreigners own commercial property investments in Australia?
Foreign Investment Review Board: FIRB advises the government on Foreign Investment Policies and make sure that foreigners understand the local investment regulations.
“The Australian Foreign Investment Review Board (FIRB) examines proposals by foreign persons to invest in Australia and makes recommendations to the Treasurer on those subject to the Foreign Acquisitions and Takeovers Act 1975 and Australia’s foreign investment policy.”The Australian Foreign Investment Review Board
The FIRB reviews the following details;
- The Type of property (i.e. Agricultural, Commercial, Factory, Warehouse, Office space etc)
- The Type of Investor (Private investor, corporate investor or represent a foreign government interest)
- The Political status of the country the investor is from (i.e. a Free Trade Agreement (FTA) partner country versus a sanctioned country)
- The Political sensitivity of the investment (for example nuclear research facilities, Darwin’s Deep sea port, defense facilities and airports are considered a sensitive business)
- The Value of the investment – this varies significantly depending on whether investors are FTA approved or not, the type of investment and the sensitivity of the investment. Check the FIRB website for the full list of current monetary thresholds. Due to COVID-19, the current threshold has been temporarily reduced to $0, meaning all foreign investments are reviewed so that Australians can be protected properly from foreign buy outs.
Countries with Free Trade Agreements (FTA) for commercial property investments in Australia
- New Zealand
- South Korea
- United States
Where to find commercial property investments in Australia
With the world at our finger tips, the best place to start looking for commercial property investments in Australia is online. There are a number of great property listing services which dominate the online property marketplace – some of the biggest listing sites in Australia being;
Once you have a rough idea of what is available, the cost, location and understand the industry or ‘niche’ of the property, it could be a good idea to talk to an actual commercial property investment agent. Examples of some of the biggest commercial real estate agencies in Australia include;
- Knight Frank
- Ray White
- Raine and Horne Commercial
- Cushman & Wakefield
- LJ Hooker
- Greg Hocking Holdsworth
These commercial real estate agents have established networks and can then hook you up with professional valuers, inspectors and solicitors – you will likely need to put together a team of professionals to help your commercial property investment journey as its not really something you can go alone.
Just remember obviously they make their money in commissions from selling a property and they act on behalf of the seller, so don’t expect them to have a buyers interest at heart – for example, if you are looking at a commercial office space, don’t expect them to tell you about the slightly cheaper office block next door!
Secondly, they also make their profits selling property management services – commercial property investment management services are similar to residential property management but a whole lot easier because there are stricter, long term leases and the Lessee are a whole lot easier to manage. It is definitely worth shopping around to find the most competitive services.
Who can advise me on commercial property investments in Australia ?
For advice on commercial property investments, you should consider assembling a small team of professional advisors. Ideally you want these to be independent, fee-for-service type operators who aren’t trying to sell you something.
Be warned there are A LOT of sharks in this industry (and the wider property industry in general) wanting to leech off of your investments, so you will need to do your due diligence when selecting and assembling your team. It is very common for financial ‘professionals’ or ‘advisors’ to simply be spruiking terrible investments so that they can receive kickbacks from financiers (like banks), land developers or builders – and these kickbacks can be as high as 10% or more!
This team might include people or services from the following areas (noting that many of these might be overlapping services);
- Property Investment Strategist
- Financial Advisor
- Project Manager
- Mortgage Broker
- Accountant (tax agent)
- Property Solicitor / Lawyer
- Property Valuation Agent
- Property Inspector
- Buyers Agent
- Real estate Agent(s)
- Property management service
Best locations for commercial property investment in Australia
When it comes to residential property, everyone talks about the rule of thumb that you can’t really go wrong with freestanding houses within 15km or so of a Central Business District in a capital city. However finding locations for commercial property investments are a bit different. For example, if we are talking about office spaces, then the CBD in Sydney and Melbourne are clearly two majorly hot markets for that (and might seem ‘safer’ than buying an office center in Darwin), but if we are talking about warehouses or distribution centers then it might be less appropriate.
The answer is the best locations really depend on the type of business your commercial property is servicing. Some factors to consider might be;
- Materials for industry / manufacturing: For example timber mills are best suited in proximity to plantation forests
- Logistics, Warehouses and Supply chain businesses are best suited in proximity to transportation infrastructure like Airports, shipping ports, highways and railways
- Population density: Tenants of commercial properties typically need employees, and many of these businesses need customer as well – for example population density is an important factor in Retail commercial properties.
You really need to have an great understanding of the property and the industry it services before making a commercial real estate investment in Australia. It is not as straight forward as choosing a residential property investment.
How to Value commercial property investments in Australia
Valuing commercial property is different to residential property, and of course depends on the type of property, its size, and location. There are many reasons by commercial property can be hard to value – for example sometimes the value of commercial properties in urban areas can be astronomical due to its potential value under re-zoning for residential housing developments. Alternatively, land may be contaminated due to industrial usage so it may actually be a significant liability for the property owner and could cost millions of dollars to properly decontaminate or rehabilitate.
You could generally get a rough idea of the value of commercial property investments by looking at online real estate listings in similar areas, but to really dive deeply into the true value of a commercial property you will need to consult a specialist property agent for that industry – they will be able to refer you to a professional commercial property valuer who can provide pre-purchase or formal offer valuation reports. There are a number of ways accountants and specialist agents can use to value commercial properties including;
Yield: Understanding the commercial properties yield is key to the value of the property. When valuing a property, you should review contracts and determine what is the true current yield. This should be compared to general market data, as well as compared with other similar properties. You want to find out whether is it below or above general market yield. Furthermore, when reviewing the current tenancy contracts, determine if the current lessees are subject to rental reviews and how this influences the yield over time. Generally, the more yield the higher the property price – but an abnormally high yield might indicate some other underlying problem or increased risk with a particular lessee. Premium retail property locations may ironically have such a high price tag that the yield is much lower than less desirable locations (or tenants), but in general a high yield may indicate higher risk.
Cap rate technique: Market Value = Net Operating Income / Market Cap Rate. This essentially values a commercial property based off the typical market yield for that industry, against the income produced by the asset. For example, with an average market yield of 7%, if a commercial property produced a net annual operating income of $100,000 (for example in rental yield) then that could be valued at $100,000 / .07 = $1.4 Million. However, other factors to consider are tenancy contracts, capital expenditure required and potential growth of the property. Sometimes this is called the Gross Rent Multiplier (GRM) technique.
Square meter technique: Breaking down your commercial property by floor-space is one of the main techniques used to value properties by comparison. For example, if an office space in an inner city. In Sydney, Australia, prime “investment grade” commercial office space retails for around $20 per square meter per week (~$1000 per square meter per year). This means if you had a commercial office space in Sydney that was 100 square meters, you could potentially look to receive around $8,300 per month in rental income. Using the cap rate technique with an average yield in office space in 2019 of around 6%, this might mean that this office space would be worth around $1.6 Million.
Location, Location, Location: Depending on the type of property, you should consider the location carefully. For commercial properties where your lessees require people for their business (foot traffic, customers or employees) you should consider visibility, accessibility, proximity to public transport, roads and parking facilities. Further, you should generally consider a properties location and position within the area, whether there are nearby business that could offer support to lessees, and if there is an absence of similar properties in the vicinity (considering supply vs demand).
Infrastructure: As touched on above, you need to look carefully at the infrastructure that surrounds the property such as public transport and parking facilities. This is something that is constantly changing, and new infrastructure developments might influence the value of the commercial property either way. For example, a nearby housing development or a new highway might mean more potential customers for your Lessee, but if we are talking about commercial airport property then this might result in an influx of noise complaints and gradually more and more restrictions, curfews and noise abatement procedures which is clearly bad for business. If you owned a petrol station in a small town, and a highway bypass is built around the town you might expect revenues to sharply fall! Similarly, if you own office space and there is an influx of Development Approvals and sky-rise office towers built in the vicinity, you might find it harder to find clients for your office space and have to lower your prices. Infrastructure and development is something you will need to keep an eye on.
Population and demographics: You should consider the population demographics near your commercial property investment – for example if you are investing in a retail store facility or shopping center, you generally want to be assured there will be enough customers nearby to support your Lessee. Similarly, building an NRL or Rugby Union field or stadium in Victoria is probably not going to be as popular as an AFL field. Gentrification of suburbs and ageing populations might generally hint at a transition towards more upmarket facilities including healthcare needs.
Building size, age and quality: This might seem a no brainer, but the size, age, build quality and flexibility of use are all significant factors on property valuation. For example, currently a very ‘hot’ type of commercial property is logistics warehouses involved in supply chain shipping – such as for online shopping. A ‘soft’ facility (i.e. a warehouse that is framed and then clad with sheet metal) means it can only be used for that purpose – sorting and storing products with forklifts and shelving. Choosing to invest in or build in a ‘hard’ facility which uses structural concrete walls or features heavy duty in built gantries or cranes means that this facility can be used for supply chain logistics, as well as for fabrication or heavy duty industrial purposes. This is one way building quality can ‘future proof’ the value of commercial property. Finally, of course the age and state of repair of facilities has a direct impact on price, as it relates to capital expenditure costs of finding (or replacing) a lessee as well as ongoing maintenance costs.
Commercial property facilities: Some commercial properties might come with desirable facilities – for example a restaurant may have had a brand new commercial kitchen recently installed. Similarly, a warehouse might come with an attached furnished office space or headquarters, along with plant equipment like forklifts or cranes. A commercial gym may be sold including equipment such as weights, machines and racks. These facilities and equipment whilst not necessary, would generally raise the price of the property for a lessee that finds them desirable – however keeping in mind that some lessees might not find this desirable, and many prefer to install their own facilities and upgrades once they have the certainty of a long term lease.
Historical pricing: Agents and real estate agencies will usually have detailed access to software and data bases of historical commercial real estate pricing. This means they may be able to estimate the current valuation based off historical pricing being adjusted for factors such as market growth and inflation.
Lessee quality: The quality of your Lessee can influence the value of your commercial property – for example the Bunnings Warehouse Property trust has rolling decades long leases with their Lessee (Bunnings Warehouse) which are indexed with yearly rent rises. Bunnings themselves pretty much covers all operational costs, and the only thing the property trust has to do is collect the rent and use this to find good quality, decently sized and competitively located land near a decent population to buy and build another big green shed. On a side note, this has been such a good business model for the property trust that they are now a publicly traded company (ASX:BWP) and something that I had even previously invested in – but more on REITs later. Generally, strong corporate lessees (big companies), long term government tenants, or even multiple tenants (such as in an office building environment) being on the books can significantly improve the commercial property prices.
Zoning and Development Approvals: Local government or council zoning is a very important factor in commercial property. The zoning permits of your property will restrict what type of Lessee you can have and the activities they can do. To get a bit silly here – you can’t just go ahead and build a coal fired power station smack bang in the middle of a suburb – even if you were rich enough to buy up enough land! Local governments are pretty strict when it comes zoning, and a LOT of money is tied up in zoning approvals and developments.
Land-banking developments are when someone buys up cheap land (Like agricultural lands) are tries to get it rezoned for residential use. Often companies ‘in the know’ can buy land to extract local resources (i.e. clay, rock, sand) for construction, and when they are finished extracting resources they can rehabilitate the land and try to get it ‘rezoned’ to either sell or develop it. If you want your eyes to glaze over, check out the NSW state government zoning laws – but in general the top tier Australian property zoning categories are;
These are then further broken down into subsets – For example Residential property is broken down into R1, R2, R3 etc which is to do with the size of residential dwellings allowed to be built, and similarly commercial and industrial property is categorised according to what it can be used for.
Getting finance for commercial property investments in Australia
Getting finance for commercial property investments in Australia is very different to residential property investments (and very different again from owner occupier home loans). For starters, owner occupier home loans are considered one of the safest investments for a lender to make, followed by investment properties in the residential property space, and then lastly commercial properties. This also roughly follows the risk / reward yield curve – with commercial properties providing higher yield and cash-flows than residential properties
Residential housing is generally thought to be quite stable in prices; there is strong government and industry pressure to keep housing prices stable or rising. This has given rise to the saying and investment slang “Safe as houses”. However, we saw this be taken advantage of during the USA subprime mortgage crisis and subsequent global financial crisis due to trading of toxic mortgage backed derivatives and credit default swaps. In general though, residential real estate is considered a religion in Australia from both investors and lending institutions alike.
Whereas with commercial property investments, it is all about free-market economics. If a property cannot produce money, or the profitability of the real estate changes (such as not being able to secure a tenant) this can have a massive effect on the price of the property. Commercial property can also be difficult to value, and is subject to swings in the economic cycle.
Not that anyone could predict a global pandemic, but COVID-19 has severely negatively affected commercial properties such as office spaces and retail property – people are working from home, and not spending their money. Overall, this means that some types of commercial property investments are seen as riskier investments – the yields might be higher, but there are more risks. In general it can be more difficult to find a tenant or client for the commercial property than a residential property – so many commercial property holders will try and get long term lease-holders to offset this risk.
As a result commercial property investments usually have higher deposits required; a typical loan would be for something like a 60% -70% LVR. These also may have stricter minimum loan balances, with many lenders requiring commercial property loans of at least $500,000 to try and weed out smaller or more risky clients. To give you an idea, a combination of these would mean an $830,000 property which should yield somewhere between $40,000 to $80,000 per year (5 – 10%) in net rental return.
These are typically interest only (IO) loans, renegotiated with the lender each year, and based heavily on the rental performance of the property. However, this is not always the case, and you can work with different lenders or mortgage brokers for a tailor made lending solution. Some commercial properties such as storage lock ups or small office spaces can be found for well under $500,000 and there are lenders willing to work with smaller clients.
Taxes on commercial property investments in Australia
- Stamp duty: Ranges depending on which state the property is in, but is typically between 4-6% of the purchase price
- Capital gains tax: If held in a personal name, you receive a 50% discount for CGT for taxes under the personal marginal income tax rate. If held in a company, there is no discount and this will be at the Australian corporate tax rate (currently 27.5%)
- Goods and Services Tax – currently 10%. You might need to register your commercial property for GST, and provide quarterly Business Activity Statements to the Australian Tax Office to pay this 10% tax. This is required for businesses earning over $75,000, but there is also long list of exemptions and specialist cases (for example Taxi’s and Ridesharing services have no minimum threshold). There is a handy article written by H&R block about GST, but you should check directly with the ATO for the full list of requirements to see if you need to pay GST or not.
“Goods and Services Tax applies to commercial property – both to the purchase price, rent received and any expenses in relation to the property”Australian Investors Association, commercial property
- Just like residential properties, you can claim depreciation of a commercial property investment among other generous tax write offs.
Buying commercial property in Australia through a syndicate or trust
If you like the sound of commercial property, but don’t quite have the portfolio, expertise or capital to do it yourself just yet, then you can invest in commercial property through a syndicate. This is where your money is pooled together with other investors and can be thought of like a managed fund. The odds are if you are from Australia and have any amount of Superannuation, your Super fund likely contains either direct commercial property holdings, hybrids or other exposures to commercial property.
Syndicated can be as simple as a private joint venture between two parties, but they can also be quite big involving many thousands of investors – this pooled capital resource is what allows the syndicate access to expensive commercial properties. Property syndicates in Australia are classified as Private syndicates (or managed property trust funds) or as publicly traded syndicates on the Australian Securities Exchange called Real Estate Investment Trusts – REITs.
Australian REITs control some of the biggest and most expensive chunks of real estate in the country, including;
- Retail property: Shopping centers (Malls), Grocery stores, Department Stores, Hardware Stores, Outlet stores and Markets
- Industrial property: Factories, Construction facilities, Warehouses and Logistics / Distribution centers
- Residential property: Freestanding homes, Apartment buildings, Duplexes and Student accommodation *Not commercial property*
- Office buildings: Office parks and business centers right through to skyscrapers
As mentioned earlier, the Bunnings Warehouse Property Trust (ASX:BWP) controls over (AUD) $2.6 Billion of real estate – which they lease to Bunnings Warehouse hardware stores. BWP buys the land, builds the shed, sets the terms of the rental leases, collects the check, reinvests some of it into new developments and then distributes the left over as a dividend to its constituent shareholders.
Not all REITs hold just property, (or just commercial property for that matter), and some are also big land developers and building companies. It makes sense for them to hold onto some of their properties through a REIT, and then they can slowly sell them off when it is profitable to do so – or hold the most profitable ones for the long term. Some of these developers are massive corporations, and are able to use their size to gobble up cheap land releases through negotiations with councils and state government.
These companies and syndicates can then either turn around directly and on sell this land, ‘land bank’ or start developing and seeking legal approvals for zoning and building. The land can be sold for significant profits once development approvals have been made, or once it has been sub divided into smaller lots. For some projects, developers will work with builders to either sell ‘off the plan’ designs such as residential housing, or physically build a site (Apartment complex or shopping center) and then either hold onto the asset or sell it off to another REIT, private real estate syndicate, equity firm or a superannuation fund.
This is a highly profitable game, and property development is a major part of the Australian economy.
There are a lot of other Australian property syndicates, developers or REITS which you can check out for exposure to commercial properties. Some of the biggest and most recognisable names include;
- Goodman Group: (AUD) $55 Billion in assets
- Scentre Group (AUD) $55 Billion in assets
- DEXUS Property Group (AUD) $34 Billion in assets
- Mirvac Group (AUD) $18 Billion in assets
- Stockland Corporation (AUD) $18 Billion in assets
- GPT Group (AUD) $25 Billion in assets
- Charter Hall Group (AUD) $40 Billion in assets
- Shopping Centres Australia (AUD) $3.2 Billion in assets
- BWP Trust Retail (AUD) $2.4 Billion in assets
- Growthpoint Properties Australia (AUD) $300 Million in assets
- Westfield: (AUD) $29 Billion in assets
It is worth noting that the assets under management is different to the market capitalization or size of the company, however its pretty impressive! I personally invest in real estate directly myself, where I can use leverage to maximise my cash flow – so I have no need to directly invest in REITs. However, I invest in broad market stock Index funds across global markets, which includes some REITs (for example, REITs make up about 3% of the US S&P 500 index) and thus give me some exposure to this sector.
What goes into a commercial property investment leasing arrangement in Australia?
The lease is the terms of contract between yourself as the property owner and the Lessee which is the business that is effectively renting the space. The lease for commercial property investments can be lengthy legal documents, and typically should be prepared or reviewed by a solicitor or lawyer and reviewed by both parties carefully. As an example, the lease should outline;
- The Length of the leasing arrangement (typically 3 to 10 years)
- The monthly cost of the lease or ‘rent’
- Any scheduled rent increases, and whether this is subject to market value or indexed to CPI
- Who has responsibility for covering expenses such as Council Rates (property taxes) or levies, Utilities bills and supply charges, Insurances and body corporate fees.
- Whether or not the Lessee is liable for general facilities maintenance
- Whether the Lessee is able to make upgrades the property (for example, installing cranes or shelving systems in a warehouse)
- Clauses subject to council approval (required for certain types of commercial properties and sensitive industries such as Medical centers or Airports)
Buying commercial properties in Australia through Self Managed Super Funds (SMSFs)
You can purchase commercial properties in Australia using a Self Managed Super Fund.
Individuals, companies, syndicates of investors and trusts can purchase commercial properties. For individuals or groups of less than five, an ideal structure to use is a Self Managed Super Fund (SMSF), so long as no mortgage is required, ie, the fund can purchase a property outright. An SMSF can also provide investors with tax benefits.John Moore – YourPropertyInvestment Magazine
Personally though, I would be a bit skeptical of this. Self Managed Super Funds are not all they are cracked up to be, and can have very expensive compliance and accounting costs which for most people make them prohibitively expensive and erode your returns. Selling property investments to people through their super is also an industry full of sharks that mostly are just chasing commissions and don’t give a rats about your financial best interests.
Given the purpose of superannuation is to reduce reliance on the aged pension and provide a bit of a ‘backup option’ for most people in retirement, I would suggest its not worth buggerising around with advanced risks on specific sectors like commercial properties. A very easy and simple way to put your super on autopilot is just with a decent sized regular contribution early in your career – invested in a low cost, diversified broad market index fund that is just left to compound for decades.
Does CaptainFI invest in commercial property in Australia?
No… at least not yet!
Personally I just have one residential property site I am currently building, but eventually I think a commercial property is where I would like to go to diversify my investment portfolio once it is more established. It is a different beast from residential real estate investments, and I think I will most likely look to purchase one or two more residential housing investments to gain experience before branching into a commercial property investment in Australia.
Whilst a commercial property investment might sound cool to brag about when your talking with your friends, it is also a serious investment tool of which the associated risks shouldn’t be understated.
Having said that, holding commercial property in Australia suits my long term investing strategy of ‘buy and hold’ as well as aligning with my values as a positive cash-flow investment. Personally, I am not into speculating or gambling on property prices, and would like to build a sensible portfolio of productive cash flowing assets that I can hold for the long term. The goal is for these to passively tick along in the background and provide me a growing stream of passive income, and it sounds like a properly structured commercial property investment might be able to do just that.
The downside is of course the requirement for me to use a significant amount of my capital to start with (which for me right now on the path to Financial Independence would honestly be better put into index fund shares), and then the need to service that loan against my personal flying income initially.
Eventually, once I have built a decent portfolio of investments in the company trust structure that is throwing off positive cash flow, I will theoretically be able to negotiate with lenders to include that as income and hence transition away from having to guarantee loans with my flying income, and hence no longer need to rely on full time work to grow my net worth.
Commercial property investments make up a huge part of the property industry in Australia. These typically are much larger and more expensive investments than residential property, requiring larger deposits for financing, and are focused more on strong cash-flow rather than capital growth. Commercial property investments are frequently structured through syndicates and Real Estate Investment Trusts due to their higher costs, unique financing needs and more complex legal contracts.
Whilst commercial property investments are typically higher yielding than residential and there are a lot of perks to this asset class, they might not have as much capital growth and this industry is not without it’s risks. Commercial Property investments have a higher risk exposure to general economic conditions – for example Australian commercial property investment yields have slumped to 9 year lows (currently averaging around 8.3% p.a.) as the retail and office-space sectors have been hit hard by the effect of the COVID-19 virus and lock downs.
I don’t personally own commercial property investments, however I am open to considering them and something I will explore in a few years once I have a few more residential properties under my belt.