Is Investing in Commercial Property still a good idea?
29 November 2019
I was recently meeting with some clients and discussing their expectations around commercial property investment.
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(For the sake of this article lets include retail, office, medical, industrial, bulky goods, and combinations of the above under the broader heading of Commercial Real Estate).
It had been a while since they purchased a commercial investment and were trying to match their previous experience of yields, prices, rents and leasing terms with current market reality. They were unsurprisingly finding it hard to purchase a “suitable” property.
There has been a real shift in the current reality of purchasing all property not only commercial. Especially when the purchasers are chasing returns on investment and reliable income into the future. With so much uncertainty about capital growth, the realization by many investors that you can’t live on capital gain, cash flow has once again become King.
With softening returns offered in banking investment products thanks to record low interest rates, many investors are turning to real estate to help provide stable income in retirement and a steady return on their investment.
This situation has created downward pressure on capitalisation rates (yields) on commercial property along with capital gain across most markets. Net Yields of between 8%-9% or better across the board on commercial properties are mostly a distant memory.
The market is generally sitting between 3.5%- 6.0%, with some options creeping up to 7.0%. If you are looking at well-known or desirable tenants in modern or new buildings with long lease terms and well located, the yields are closer to the 3.5% - 5.5%, the with purchasers banking on the annual fixed rental increases to help improve the returns over time.
Commercial
investments are still defiantly worth considering, however, the need for
purchasers to do more research and to gain a much better understanding of what they
are purchasing is becoming increasingly critical.
Some investors are falling into the trap of buying a cash flow, as opposed to buying the real estate. -Good real estate will always attract good tenants/cash flow.
If you are buying a property based solely on the perceived good quality of the tenant, without a lot of regard for the real estate that comes with that purchase, you could end up in a difficult situation if you lose that tenant.
A good example of this are ex Dick Smith stores – some were well located and have been relet, others that were oversized or poorly located are still struggling to get back on their feet.
The current environment has created the situation where some residential property is yielding better than commercial property. The lending criteria of most banks for a while particularly in the SMSF space forced investment into commercial property, and that in part has helped drive down the yields, as SMSF try to achieve investment returns that are considered reasonable in comparison to bank interest.
The lowering of yields is impacting on the amount of funds retirees now require to sustain themselves thus adding to the demand for real estate and in particular commercial property, which historically is know for providing better cash flow.
A good take away from this, if you are considering commercial property investment, would be to buy the best quality property, in the best location, with the best yield you can afford. – No surprises there – but once you start researching, the task becomes much harder to see the wood for the trees.
