So we have been talking about risk versus reward, and we keep coming back to the point that commercial property investments have the ability to produce greater returns. We have also talked about some of the key differences between residential and commercial properties.
Continuing on that note, just about every investor wants to know the value of their property. In the residential space, investors need only look at comparable listings to get an idea of the property value. Commercial property, however, is a bit more… shall we say, “specialised.” A variety of growth measures determine the potential property value. Here we’ll look at those drivers so you can better evaluate your existing properties or any properties on your “investment wish-list.”
Commercial Property Growth Drivers:
The fundamental growth drivers in the commercial market are economic factors and population growth. Feeding off each other, these two factors have a symbiotic relationship: when the economy grows, the demand for warehouse/industrial space follows suit, which, in turn, increases demand for retail space because consumer confidence is higher and people are willing to spend more money. This has a carry on effect, increasing demand for office space. It breaks down like this:
Higher rates curb the economy, which curbs company growth, usually leading to a tightening of the consumer’s purse strings. Lower rates have just the opposite effect - company expansion and consumer spending increase, causing a supply and demand growth.
Particularly in access ways, such as freeways and bypasses, new infrastructure expands the “city” boundaries to lower-cost lands, making more room for affordable growth. The sprawl of businesses and consumers motivates transport companies to move their warehouses, for example.
Where there are people, there’s more opportunity and need for services. This draws the traditional conveniences: grocery stores, coffee shops, restaurants and ultimately, office space. Demographics play a significant role here too. Young families move to locations with child care and schools. And as more people seek a work-life balance, many are moving closer to the job, creating new opportunities.
Consumer confidence or retail spending:
Consumer confidence drives spending, and when spending goes up, it drives the need for more warehouses and retail outlets, office space, etc..
Further, redevelopment and tax-related factors also come into play. If you’re considering entering the commercial market in the development stage, Acumen Finance, an expert in commercial real estate construction and development financing, can help you understand how these variables will affect your intended project. Call today to talk to one of our specialists.
While all these factors combine to fuel growth which affects commercial property values, ultimately, commercial space is only as valuable as the leases it holds. Therefore, the fastest way to increase a commercial property’s value is to find a tenant or to increase the rent.
Over the past couple of years, Australia’s commercial market yield appears to have “flattened.” In fact, it has experienced a “compressing” of the yield spread between industrial and both office and retail space. What is compression? As it is topping the list as the most preferred commercial property sector to invest in across the Asia-Pacific, let’s look at Logistics for an example.
The driving factor here is economics: businesses are optimising their supply chains and warehouse footprints. As a result, investors are now viewing logistics as the retail of the future - particularly in major transport centres and with the growing interest in “last-mile” delivery hubs.
Essentially, investors have driven down industrial yields to gain entrance into the market, according to an industry survey by ULI/PwC. As a result, investors “captured super-normal gains thanks to record low yields and extraordinary price growth driven by low-interest rates” says Dr Frank Gelber, Head of Property for BIS Oxford Economics.
At the end of 2018, commercial property yields in Australia were at record lows, around 4.75% to 5.0% for high-quality offices and retail, and just above 5% for high-quality industrial space. In reference to the yield compression, Sean Ellison, RICS Asia Pacific senior economist cautions that, “Even when you have this sort of slower growth, it’s not really sapping the demand from commercial real estate.”
All in all, underlying economic growth and high yields relative to other Asia-Pacific countries are combining to make Australia - specifically, Sydney and Melbourne - home to excellent prospects for commercial growth, appealing to both domestic and international investors.
The 2018 Australian Property Outlook report published by BIS Oxford Economics predicts that, across Australia, office space in will be the prime performer over the next five years, with Sydney expected to fetch 10% internal rate of return, followed closely by Melbourne at 8.2%, and Canberra at 7.5%. Brisbane will be the market to watch for yield growth in factories.
And Knight Frank’s chief economist says that they expect the investment market in Australia will rise to new records in 2020. The Outlook 2020 Report predicts that total return on commercial property (both yield and capital growth) will exceed 10% in Sydney and Melbourne this coming year.
Dr Gelber predicts that “the main driver of property prices and total returns for investors will shift from yield (rental rates) to leasing conditions and rental growth...We expect further strengthening in rental income off the back of strong demand-supply fundamentals and tightening vacancies.” They also predict large-format retailing - as opposed to shopping centres - will increase by as much as 8.5%.
The Right Backing
Big banks are writing fewer commercial loans these days. When they do, they usually require a significant down payment, a business plan, cash flow projections, and 12 months of profit and loss statements for existing businesses. Then you may have to wait weeks - even months - to find out if you’ve been approved. It’s a lot of time and effort, and risky too if there’s a hot opportunity knocking. Credit Unions and Building Societies (tier 2 lenders) are a good source when looking for a commercial mortgage loan. They are able to process loan applications more expediently than the big banks, but you will still need to present substantial research and solid paperwork to back the merits of the deal.
Private lending, on the other hand, is much more flexible with application requirements and usually much faster than either tier 1 or tier 2 lenders. Through the private sector, you can find loans to fit a variety of needs, without financial caps. The deals are negotiated and settled based on merit and potential. Private loans are an excellent source of funding for unique situations or projects, such as interest-only loan, where the initial payments are low, freeing up cash flow. Also, banks and Credit Unions are very conservative when it comes to development financing or construction financing due to cash flow issues and risk. At Acumen Finance, private lending and specialised loan products are our specialities. We work directly with a conglomerate of investors who understand the commercial mortgage and the commercial development space. With decades of experience closing construction and development deals, we have the in-house expertise to match you with a funding product that works for you and your project. Contact us to get started.
It appears that the future is bright for commercial property investors. Obviously, you’ll need to consider several factors before closing the deal: economics, consumer confidence, location, and infrastructure, to name a few. If you need some expert advice on how to begin, check out our upcoming article, How to Get Started in Commercial Property Investing.