Our Guide To Commercial Property (2019)
Last updated 17/06/2019
We can all agree that commercial property can be a risky investment. So why is it still so appealing? How can you make it pay off?
It offers less burdensome management input than any other, plus boasts a good long term income and capital growth opportunities, based on rental value growth - when selected carefully.
This class is differently affected by:
- Shifting demographics
- Potential changes in population
- And requires a keen eye for potential changes in legislation.
Finding the best commercial property with all 3 benefits long term means assessing several different types of commercial property and their sub-sectors.
Industries to choose from within this sector include:
- Retail spaces
- Alternative properties such as car parks and healthcare spaces.
Assessing the appetite for risk and performance requirements
The business strategy and performance of the occupier are key to the desirability of a commercial property.
A household name and a prime location are both seen as good indicators for a high ROIs (Return On Investment).
Income return must be thoroughly assessed, as the retail sector in particular is subject to radical change in a relatively short amount of time.
Could anyone have predicted the astronomic rise of online shopping, or that online giants like Amazon would make their own attempts at physical retail?
Key Point: Make sure you’re analysing modern trends.
Although ‘location, location, location,’ is important in the residential property market, it doesn’t attract such huge potential downsides in commercial as it does in some other sub-sectors.
This is why your assessment strategy is crucial.
In the case of retail, ask to see existing leases of the surrounding property so that you can check whether there are downwards or upwards trends.
Are any big name brands looking to move out?
Are businesses triggering their break clauses early?
If so, think twice before investing.
Successful commercial properties
There have been a number of retail brands bucking the trends, like Matalan’s with it’s 5% revenue increase.
- Have a clear understanding of which brands are successful
- Look at long term leases and it’s terms
Car parks have become a growing property investment opportunity. Many investors see them as an attractive opportunity to diversify their portfolios.
Commercial property is favoured amongst both institutional and smaller investors. It is less management intensive than both residential and PBSA (Purpose Built Student Accommodation).
The tenant takes full responsibility for upkeep and refurbishment, often on a FRI (Full Repairing Insurance) lease.
This reduces the burden of asset management to regular inspections. Ensuring compliance with the terms of the lease and rent reviews when the lease requires review or renegotiation, e.g when a break clause is activated.
1. Long-term income – Typical dividend yield 4.5% – 5.5% per annum
These are standard rental increases when adjusted for inflation:
- With a brand name business as a tenant
- A long unexpired lease term with built-in upward only rent reviews
The above is based on a FRI lease with a minimum of 15 years remaining. We can be confident to let the same unit to an alternative tenant, particularly if there is a break clause.
2. Active income – Typical dividend yield >5.5% per annum
The higher risk in this type of lease impacts:
- The value of the property
- By increasing the yield once an extension of at least 7 remaining years on the tenant’s lease is negotiated.
This increases the rental income and/or value of the property.
If you can be confident of letting to an alternative tenant should the property become vacant once the lease expires.