Commercial Property Explained & How We Select It

Last updated 09/11/2018

Property, Commercial, Income + 1 more

Commercial property explained and how we select it: sounds simple enough, doesn't it?

This asset class, more than any other, offers less burdensome management input, good long-term income and an opportunity for capital growth, based on rental value growth. That is, if you select carefully.

Shifting demographics and other potential changes in population, as well as reading ahead regarding potential changes in Government Legislation affect this asset class in a way not reflected in any other e.g. residential property. Finding a prime site commercial property that is going to offer all three benefits over the longer-term involves assessing several different types of commercial property which fall into sub-sectors. Industries to choose from within the commercial property sector include Offices, Entertainment, Industrial, Retail, and alternative properties such as car parks, petrol stations and healthcare.

Investment in commercial property needs to be based on appetite for risk and performance requirements.

The desirability of a commercial property is strongly linked to the business strategy and performance of the occupying tenant; this could be a household name and that is linked to being in a prime location and also income is likened to Bonds. Return on investment is not usually thought of in this way in the residential property market.

Commercial property explained in terms of an Acquisition Strategy means assessing the income return particularly carefully as online shopping and other technologies have significantly impacted on core sectors such as retail, office and industrial. Although location is important in the residential property market sector, it does not generally attract such huge potential downsides as these sub-sectors, for example, if major brand names decide to pull out of a shopping centre complex in a prime site. That’s why looking at longer-term leases and their terms is so important.

There are two significant upsides to investing in commercial property

First and foremost, it is favoured among institutional investors and smaller investors alike, as it is less management intensive than residential and PBSA (purpose-built student accommodation). In the case of commercial property this is because the tenant takes full responsibility for the upkeep of the building and refurbishment, often on a full-repairing lease (FRI). Asset management here, in practical terms, means regular inspections to ensure the terms of the lease are being kept up, and rent reviews when the lease requires renewal or renegotiation, for example, as a break clause is activated.

Commercial property complements any residential property investor’s portfolio for these reasons:

Long-term income – Typical dividend yield 4.5% – 5.5% p.a.

Guaranteed rental increases adjusted for inflation with a brand name business as a tenant and a long, unexpired lease term with built-in upward only rent reviews. Hence the analogy with fixed income investments such as bonds. A full repairing lease with a minimum of 15 years remaining; confident of being able to let the unit to an alternative tenant, particularly if there is a break clause.

Active income – Typical dividend yield >5.5% p.a.

Higher risk in that the lease is such that it impacts the value of the property/ increases the yield. Includes negotiating an extension to the tenant’s lease which will have at least 7 years remaining on the lease, which increases the rental income and/or value of the property; confident of letting to an alternative tenant should the property become vacant when the lease expires.