How does commercial property investment work?

How does commercial property investment work?

October 11, 2019

The process for buying a commercial and residential investment property is the same; you find the right property, negotiate your finances, find a price agreement and run through the paperwork with your conveyancer.

The real difference between residential and commercial property investment is in your mindset and targeted end result.

One trap that is easy to fall into with commercial property purchases is the rental income appeal. It's high, so much higher than residential and you typically will buy a property with a tenant with a long terms lease. It can mean that your eyes fill with dollar signs and you jump in before really thinking it over. Just like everything else you need to be looking at the high yield and asking, what's the catch because there are risks involved, that lease income is deliberately high to cover things like, vacancy periods, high-cost maintenance and low capital gain. For example, if you held onto a residential apartment and a warehouse for a 30-year duration, your capital gain for the apartment would be 40% higher than your commercial space.

Think of it this way, the higher the yield, the bigger the risk.

When you are looking at commercial investment properties, ignore that big fat rental income and switch over to think long-term, so basically get out your crystal ball and try to predict what your profits will be like in ten to twenty years. It's no easy task. It takes a lot of research, a super large investment and a calculated amount of risk.

So why do it? There are perks to commercial property investment, obviously, or no one would invest.

Wide range

The first thing is the flexible options. A commercial investment property could be anything from a traditional high street flower shop to an office block, service station, factory or department store. That means there is a fit for every budding portfolio creator.

Long term leases

It's usual for a tenant to enter into a lease of 3-5 years (or more), offering you a steady income and peace of mind (providing they can stay open for the full lease period). It's far less work and disruption than short term residential leases where you may see comings and goings every 12 months or less.

Great cashflow

When it comes to leases, commercial property investment can bring in up to three times more than residential investment properties.

Responsible tenants

Your tenants can usually be required to cover pretty much all the ongoing costs, even including rates, updating fit out and amenity fees. That means they care about the property and are less likely to cause damage or run amuck. Make sure your commercial property conveyancer reads over the lease terms of agreement carefully, so you fully understand what is taken care of and what you are still responsible for.

How to make it work

In order to get a commercial property investment to work for you, you need to do careful research into the kind of income you want to be receiving.

1. You need to be willing to commit

Commercial investments are not typically the best option for new investors. Commercial purchases need big deposits (25% to 50%) and a deep account to maintain them and cover any vacancy periods. Vacant commercial buildings tend to stay that way for months at a time and usually will require a major overhaul or high-class maintenance to attract a new long-term tenant as well as possible bonus incentives like a month's free rent.

When everything is going well, it's going really well, when it's not though it can be a financial disaster. If you don't have a focused long term financial commitment to the property it will become more outdated and run down, making it even harder to find tenants.

As well as covering your loan repayments while not receiving income you'll also need to pay any overall building management costs, which can be high. So lights, security, and cleaning will all be billed regardless of if your investment is open for business or not.

2. You need to put your terms and conditions to work

You need to work with your conveyancer or lawyer to understand the terms and conditions of your purchase and your lease inside and out. There are plenty of variables to be cautious of but also that you can take advantage of to help get you ahead and make the property more financially stable. For example, it's also usual for price increases to be inbuilt in the terms.

Get great advice on the legal side of things so that someone's knowledge is on hand to look over the fine print for inclusions, deletions, and bumps that may trip you up or springboard you forward.

3. You need to look closely into your crystal ball

You want to be buying the right kind of asset in the right location so that your property will be highly sought after and you can attract great tenants. That means incredible research.

As well as helping provide security and stability to your income nabbing a solid property type will also grease some wheels with lenders so will create a risk assessment to determine what your upfront deposit will be.

Commercial property purchase is a bigger risk than a residential property with more details to take into account. You will need legal advice as soon as you have found a suitable property and you need to be prepared to wait out signing the contract until every section has been combed through and all conditions have been completed.


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