Essential Guide to Buying Commercial Property

As of April 2024, all the commercial property in Australia was valued at $1.2 trillion per CoreLogic, making up more than 10% of the overall market.

There are plenty of investment opportunities and not just for large funds or institutions.

Commercial property covers 75 m2 shop fronts as well as industrial scale warehouses, so there may be options for you even if you’re investing on a smaller budget.

Types of commercial property

Any property that is used for business activities rather than a place of residence is commercial. These are the most common types:

• Office space
• Industrial parks like warehouses
• Retail outlets
• Development sites

Commercial property loans

The type of loan you’ll need for a commercial investment depends on what entity you are buying it through.

Buying as an individual

Commercial real estate can be bought in your own name without an ABN, just like a residential investment property. According to the ATO, you’ll only need an ABN for commercial investments if you are “running an enterprise”. Buying the property to flip immediately or to develop upon are examples of what the tax office considers an enterprise. If you are just buying to generate passive income, you will likely be able to do so without setting up a commercial entity, or registering for GST. The same also applies if you are buying through a trust.

SMSF loans

It’s also common to buy commercial property through a self managed super fund (SMSF) using a limited recourse borrowing arrangement.

There are several providers in Australia who currently offer commercial property SMSF loans, including:

• loans.com.au
• La Trobe Finance
• Liberty Finance
• Bank of Queensland (through its specialist banking services)

Buying through a business

If you’re a business owner, you might be thinking about buying rather than renting the premises you run the company out of. To buy in the name of your business, you’ll likely need to take out a business loan.

Alternatively, some business owners buy commercial property through an SMSF then lease it to themselves. Since superannuation income is taxed at only 15%, this can be a tax effective solution, but these transactions need to meet certain conditions - the property must be exclusively used for your business activities, for example.

Pros of buying commercial property

There are a few things that make commercial investments attractive compared to residential property.

Higher yields

Annual rental yields on commercial real estate tend to be significantly higher than residential property. This means it's easier to find investments that are positively geared, generating a passive income.

Per Ray White and MSCI, these were the average annual returns over a ten year period as of 2023 for various types of commercial property in Australia.

Meanwhile, average rental yields on residential property have fluctuated between 4 and 6% over the past 10 years according to SQM research.

Long term leases

Another advantage of commercial property is that businesses often sign long term lease agreements compared to residential tenants. The typical renter signs a lease for six to twelve months, with longer terms fairly rare. Commercial tenancy agreements meanwhile can range from a few years to decades depending on the type of business. Extended leases can mean a more stable income, and needing to find new tenants less frequently which can save on advertising and other property management costs.

Diversification

If you already have an investment property or two to your name, adding commercial real estate can help diversify your portfolio. While the residential market is generally considered a safer option, crashes are not impossible, 2008 and the GFC being a prime example. As any financial advisor will tell you, adding variety to your portfolio reduces your exposure to any one sector.

Drawbacks of commercial property investing

As with any investment, commercial real estate isn’t all upside, and there are a few things to remember before you dive straight in.

Higher deposits and barriers to entry

Commercial property loans generally require a deposit of at least 20-30%, while residential property can often be purchased with a much larger LVR. Larger commercial property can also be much more expensive than houses, so aren't really viable for investors on a smaller budget.

Fluctuating demand

‘Safe as houses’ is an aphorism that contains an important truth about property investing. No matter the condition of the economy, everyone always needs a roof over their head, which is why residential property is generally considered to be one of the safest investment classes. Demand for residential homes is considered ‘inelastic’, which means it is less susceptible to price changes because it can’t be replaced with something else. For example, if house prices or rent goes up, people generally can’t buy a car or a shed to live in instead.

On the other hand, demand for commercial property is more exposed to the wider economy. During a recession, when the economy is contracting, businesses may downsize or even go bust, which can bring down demand for commercial or retail spaces. Economic downturns could mean the commercial property is not tenanted for an extended period, which means the investment isn’t generating any income.

What makes a good commercial investment?

Tas Costi, co-founder of Costi-Cohen buyers agency, says there are plenty of other ways to assess a commercial property beyond the estimated returns:

• Existing lease. Buying a property with tenants that already have a long term lease agreement is arguably the most seamless way to enter the commercial market.
• Future tenant viability. One of the most important considerations for a commercial investment should be how viable the property is for tenants. A shopfront in the middle of nowhere isn’t ideal, while an industrial park near the city centre could be impractical. The location, area demographics and the condition of the building are all factors in how attractive the property is to tenants.
• Development upside. Just like with residential property, developing commercial real estate can unlock potential capital growth. However, this also likely means you’ll need an ABN, and may have to register for GST.

Commercial property in Australia outlook

Capital growth for commercial property tends to vary depending on the type of property. For example, since the beginning of Covid, industrial property values in Australia have grown nearly 50%, while retail spaces were more than 15% cheaper in December 2023 compared to 2019.

This shows capital growth for commercial and residential property over the past few years, indexed to December 2019. Industrial property outpaced both houses and units, but the residential property classes offered significantly better returns than retail and office spaces. It’s important to take the pandemic into account here, particularly when it comes to retail as lockdown inevitably saw a nosedive in the value of shopfronts.

Moving forward, Mr Costi recommends investors on the hunt for a passive investment look at “recession proof” commercial properties.

“Asset classes such as retail, industrial or alternatives [like] service stations and medical centres are the safest bet in this current market,” he told Your Mortgage.

“Buyers should be targeting opportunities that are occupied by strong tenants and located in blue chip or high growth areas.”

He said that despite a recent slight uplift in the office market, the rise of work from home is a threat to the sector.

“Office assets need to be occupied by long-term, national tenants with good lease terms, otherwise I wouldn’t consider them a great investment.”

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