Commercial Property Investing: The Numbers

Australian commercial property has been a hot topic for the last few years, and it doesn't look like slowing down anytime soon. 

Many investors are drawn to the commercial property space because it has a higher return than residential real estate, which makes it more appealing for those looking at long-term investment strategies.

But, commercial property is all about the numbers. In other words, it is essential to consider objective measurements of success when determining whether or not a commercial property is worth investing in.

So, with that in mind, we want to share with you what you need to know when looking at the numbers of commercial property investing. 

What Numbers Should You Analyse when Considering a Commercial Investment?

Investing in commercial property is a complex and lucrative endeavour. The numbers can be daunting, but if you're looking to invest in commercial property, you must understand what the numbers represent and how they affect your bottom line.

You should analyse the following numbers when you’re considering a commercial investment purchase: 

• The purchasing costs 

• Yields

• Leases

• Outgoings 

• Depreciation

• Capitalisation rate and property value 

• Cash flow 

• Capital growth 

Understanding these numbers is important for all investors to make informed decisions. 

THE PURCHASING COSTS 

Commercial properties have the same purchasing costs as a residential property but with a couple of additions. First, in terms of a deposit, you’ll need to secure the commercial loan with at least 20% to 35% of the purchase price. And in terms of buying costs outside of your deposit, you’ll likely need to spend around 5% of the purchase price.

Example: 

Suppose you have $150,000 to spend, and the lender requires a 30% deposit. You also need to allow 5% for purchasing costs, such as stamp duty, GST, valuation fees and conveyancing fees, bringing the total up to 35 per cent. 

If $150,000 represents 35 per cent of the total, the maximum you can spend to buy a property will be $428,571. So, you should be looking at properties that cost less than $425,000.

COMMERCIAL PROPERTY YIELDS 

The yield of any property, including commercial and residential properties, is the annual rental income you’ll receive from the tenant in relation to the purchase price. A commercial property yield is typically expressed a the net yield (i.e. rental income less expenses) and is calculated as follows: 

Example

Property purchase price: $500,000

Gross income: $43,000

Outgoings: $7,000 (paid by owner)

Net rent: $36,000

Property yield: $36,000 ÷ $500,000 = 7.2%

BUYING LEASED COMMERCIAL PROPERTIES

A lease is an agreement that allows the use of a premises or building by a tenant to conduct their business in return for the payment of rent to the owner of those premises. So, when you purchase a leased commercial property, you are buying a guaranteed income for the defined lease period. 

As the buyer, it’s not necessarily essential to understand every detail of the lease because that’s your solicitor’s job. But, it’s important to at least be familiar with the lease terms so that you can secure your commercial property and negotiate the terms going forward. 

Almost everything is negotiable in a commercial lease. As the landlord, your main focus should always be on ensuring that your property is a solid investment with a good long-term tenant.

Most rental increases for each year of the lease will be the same as the Consumer Price Index (CPI) or 2% to 5%.

OUTGOINGS

Outgoings are expenses that a landlord incurs directly from owning a commercial property. Depending on the terms of the lease, the owner or tenant can be responsible for paying them. These costs can make a big difference to a tenant’s or owner’s bottom line and must be accounted for. 

Some outgoings that you should be aware of include:

• Council rates: calculated by your local council based on its location and comparable vacant land

• Land tax: state-based tax applicable to properties that fall above the threshold 

• Property management fees: charged by a real estate property manager for managing the property

• Water and utilities: usually paid by the tenant 

• Body corporate fees: the body corporate is the entity that manages the common property of a building or complex.

• Insurance fees: to protect your asset should something unexpected happens (includes building, landlord and public liability insurance 

• Maintenance: all properties require general maintenance 

DEPRECIATION

Depreciation is the loss in a property’s value over time due to ageing and wear and tear. You can obtain substantial tax and depreciation benefits from commercial properties. Although owners of residential properties can also claim depreciation, it’s more significant for commercial buildings because they’re generally larger and typically have a more expensive construction and fit-out.

Depreciation deductions can be broken down into capital works and plant and equipment. 

Capital works deductions refers to the building’s structure and any items considered permanently fixed to the property, including the building itself and any structural improvements. Plant and equipment are assets that the Australian Taxation Office (ATO) deems easily removable or those that are mechanical such as air conditioners, refrigerators, ovens, fans and carpets. 

Capital works are usually depreciated over 40 years, while plant and equipment assets are depreciated over their effective life. 

CAPITALISATION RATE AND PROPERTY VALUE

Capitalisation rate or ‘cap rate’ is a concept used to determine a property’s market value at any point in time. The rate is based solely on a property’s net operating income and purchase price, without adjusting for debt, mortgage repayments or purchasing costs. 

The cap rate can be used in several ways to help you compare investments and remove the guesswork from buying and valuing properties.

Example: 

If you purchased a property for $1 million and it returns $50,000 in net rent per year, it has a cap rate of 5%. 

Low cap rates are an indication of stable tenants, high-foot traffic and solid locations. On the other hand, high cap rates may indicate high vacancy periods, quiet areas, or a tenant in a dying industry. In other words, the higher the cap rate, the higher the risk of investing in that commercial property. 

CASH FLOW

Cash flow is one of the largest considerations for an investor buying a commercial property. The cash flow is the income the property produces after all expenses. 

CAPITAL GROWTH

Much like the residential property market, the commercial market moves in cycles. There are several factors that affect capital growth, including: 

• the economy, 

• interest-rate changes, 

• infrastructure spending, 

• individual property factors, 

• lease length, 

• rental increases, and

• cap rate.

Here’s a diagram illustrating the cycle of the commercial property market clock:

If you do your due diligence correctly, you can mitigate most market fluctuation risks and so profit in the long term.

Key Takeaway

The decision to invest in a commercial property is often an investment of both time and money. You need to know that you’re making the right choice before committing yourself, so it pays to be thorough when considering all factors.

Understanding these six numbers will help you make an informed decision about whether or not a commercial property is worth purchasing.

Get in touch today if you would like to know more about how I have helped thousands of clients successfully source and purchase quality commercial property across the country.