Pros and Cons of Commercial Real Estate Investing

With due diligence, risk management and the right partner to help you navigate your course, Commercial Property Investing may be your ticket to great rewards.

Nathan Daly
May 21, 2020

Pros and Cons of Commercial Real Estate Investing

Everyone wants their investments to have a significant rate of return; in fact, the higher, the better. Yet, we all know the greater the risk, the greater the reward, the lower the risk...well, not so much reward.

For those who are ready for some inspiring ROI, Commercial Property Investment offers a wide range of opportunities, and there are more options available than with residential investments. Contrary to popular belief, there are many ways to enter into commercial property investment, and at reasonable entry points. Think smaller buildings, such as local retail or office space or a car park, or Limited Partnerships for passive investing.

If you’re ready to move into the investment big leagues, contact Acumen Finance for a consultation on the property climate for commercial property investing, financial modelling, and get advice from our expert development and financing professionals.

What is Commercial Property?

Commercial property is defined as units, office, retail, industrial, multifamily (more than 5 units), hotels, and special-purpose buildings, such as day-care centres or even car washes. Generally speaking, commercial properties are leased to businesses - and this is the beauty of the market.

While there are disadvantages in commercial property investing, the advantages are numerous, so we’ll start with them:

Pros

Higher rate of return: Compared to that of residential properties, the potential income from commercial investments can be much more lucrative, yielding as much as 12% in some parts of Australia - although it is lower in some of the bigger capital cities. With commercial property, generally speaking, you’ll have more tenants which equates to more cash flow.

Depending on your property investment, commercial tenants are often backed by a larger company. And because businesses like stability, they will typically sign longer leases - 3 years and up is pretty standard.  With longer lease terms, you can build-in rate increases, so you don’t have to negotiate every rate hike, making it easier to keep pace with inflation without the stress.

Also, well-established businesses are more likely to sign a Triple Net Lease and assume the responsibility of paying for all the expenses, including taxes. This leaves the property owner responsible only for the mortgage payment. Depending on the condition of the investment, commercial property investment is pretty “hands-off”, not typically requiring daily interaction from the investor.

Commercial real estate is valued almost entirely on the cash flow it generates. While the property value will fluctuate in accordance with comparable properties in a similar location used in the same manner, a commercial property’s value is largely predicated on the leases it holds. Accordingly, if you have a commercial building with low-vacancy rates and big-name tenants, the value of the property increases. By extension, any improvements to a commercial property that increases revenue will increase the value of the property.

Cons

Unfortunately, businesses come and go with alarming regularity. Since commercial tenants are harder to come by, investors should be prepared with significant financial buffering to compensate for the possibility, in fact, of longer vacancy periods. That said, if you house well-established businesses, they will attract other businesses, eager to capitalise on the draw of the big-names, and allowing you to negotiate more favourable lease terms.

While property maintenance is not specific to the commercial space, it is critical to your success as the property is the base of your tenants’ day-to-day business operations. Maintenance issues that affect a business’ ability to function will need to be addressed with haste. And it’s likely to cost more in the commercial space - another good reason to have a liquid reserve.

Capital growth is determined by many more variables, and the market is more volatile. The economy - including that mercurial little thing known as business confidence - will be a determining factor. This can be daunting to some because it’s difficult to determine your investment growth on a day-by-day basis. On the other hand, the value of a commercial property is determined by the leases it holds, not so much on the land on which it sits (which still factors in, obviously - remember: location, location, location). For example, if you’ve got a “five-by-five lease” (a five-year term with four more five-year options) with a big name brand like Bunnings, that’s a great lease that stands a decent chance of weathering economic fluctuations.

Larger down payment. This may be the single biggest obstacle for the first-time commercial investor. While there are affordable options out there, commercial loans tend to come with a lower loan-to-value ratio, meaning you’ll have to come up with anywhere from 40 to 60% of the purchase price for the down payment. There are, however, some creative ways to enter this market - including using other under-performing investments you may already have, such as an SMSF.

Entering the commercial real estate market requires some expertise - analysing the deals are more complicated. Before investing, you’ll need to know property details such as maintenance records, expenses, rental histories, and for sure you’ll want to see the last 12-months of Profit and Loss statements. Also, you’ll want to be a forward thinker; it’s not only determining what is in demand now, but what will be in demand five or ten years from now. Due diligence and creative thinking are key to your success, as is sound advice from a professional who understands the intricacies of investment lending and commercial mortgage lending.

The Next Step

Commercial property investing is serious business intended to return serious results. It might be a bit riskier, but some due diligence, careful planning, a cash reserve, and a watchful eye on market opportunities could result in significant capital growth.

As we mentioned, big banks will usually require a significant down payment when speculating on commercial property. They do this in part to ensure that you, as the investor, are vested. But the big banks are not your only option. Tier 2 lending - Credit Unions and Building Societies - are a good source when looking for a loan. They have a better reputation for being able to process loan requests faster than the big banks, but still, you’ll have to prove the worthiness of the deal. Be prepared with homework in order - business plan, financial statements, 12-months of P&Ls, and a good credit rating.

For greater flexibility - deals negotiated and settled based on merit and a keen sight into future potential - there is the option of private lending. Through the private sector, you can find loans to fit a variety of needs. For example, if you just need a short-term loan to get a deal across the line, consider an interest-only loan - the initial payments are low, freeing up cash flow. The time it buys will allow you to restructure loans and assets to secure a deal at a lower interest rate once the income flow is established. Private loans are also convenient for development financing or construction financing because the private loan allows you to negotiate terms and exit strategies that regular banking institution cannot or will not consider.

Property values across Australia have experienced a downturn since 2017. But they’ve landed, and current market activity indicates upward momentum. Don’t be left standing on the sidelines, watching as the opportunity passes. If you’ve ever wanted to enter commercial real estate investing, this is the opportunity.

As a direct conduit to private and corporate funding sources, Acumen Finance does not impose any lending caps - they are able to write loans for any amount. Drawing on a suite of financial products designed to fit almost every need, they take personal service to the next level by offering sophisticated financial modelling to determine the best solution for even the most unique projects. Backed by a team of experts in accounting, construction and development, and financial structuring, they are connected to a pool of savvy investors wanting to help. Acumen Finance is in the unique position to help you realise your commercial property investment dreams. Call today to speak with our knowledgeable and helpful staff and start your foray into the commercial sector.