Direct investment in commercial property is typically better suited to experienced investors who have built a residential portfolio and want to diversify their assets. However, many investors fail to consider some of the most basic principles of commercial property investment.
Here are four general tips that will help to identify a good commercial investment property that delivers higher and more consistent returns.
1. Favourable lease agreements
Commercial property leases can be between three and 20 years, depending on the size of the premise and type of tenant. Therefore, investors acquiring a tenanted commercial property need to be particularly aware of the conditions of the lease agreement.
Properties may be marketed with a ’10-year lease’. However, clauses in the contract may allow the tenant to vacate sooner without penalty, or there could be rolling optional exits every three years, for example.
2. Multi-tenant properties
Acquiring a multiple-tenant property mitigates disruptions to cash flow in the event of vacancies. For example, take a commercial premise that can only be leased to one tenant. If that single tenant leaves, the owner will need to manage without rental income until the premise is re-leased. For example, owning premises with three separate retail spaces with three separate tenants means if one tenant were to leave the owner would still receive rental returns from the two remaining tenants.
3. Look past the headline rental returns
Ensuring the property provides high returns might seem obvious, but many investors fail to understand the total yield a property will deliver. For example, a property may have a headline yield of 8%, but rental reviews could be linked to the tenant’s performance, meaning rent increases may only occur if the tenant is recording a certain amount of revenue. This could weigh heavily on investor returns if the tenant’s business is underperforming.
Investors also need to consider incentives paid to the tenant, vacancy periods and outgoings not recoverable from the tenant. These items will all have an impact on the final yield that a property delivers.
4. The quality of an existing tenant
A high-quality tenant provides peace of mind that the tenant will pay their rent on time. National franchises, large publicly-listed companies or multi-national corporations are good examples as they are typically well-established and profitable businesses. Do your homework on the tenants as part of your due diligence when buying a property.
While there are many factors to consider when buying commercial property, these are a few key considerations for investors.
Damian Collins is Founder and Managing Director of property investment consultancy Momentum Wealth. This article is general information and does not consider the circumstances of any individual.