Commercial Property Buying Guide

By Aldo Galante November 08, 2017

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Buying a commercial property can be a daunting process. Before you invest in a commercial property you should have a very clear understanding of the following:

RETURN

Your investment returns will come in two forms, through rent collected (yield) and potential capital growth when you eventually sell your property. The two streams added together will give you the total return on your investment property.

You should take care in assessing the potential returns on your property so that you can compare them with potential returns from other investment properties and other asset classes such as shares and term deposits. As a general rule, properties with strong potential for capital appreciation will sell on lower yields. The lower yield is balanced out by a potentially larger capital return on sale of the property.

Properties that occupy prime locations with limited vacancies and strong historical rental growth will sell on lower yields. For example retail shops in Glenferrie Road Hawthorn typically sell on yields of 3-4%.

The reverse is also usually the case. Properties in areas which have historically not experienced strong capital growth and have a large supply of available stock will sell on higher yields. Industrial properties in the outer suburbs often sell on yields of 7-8% and the higher yield is offset by lower potential for capital returns.

Total return is also affected by factors such as any regular outgoings and the prospect of capital works that may be required when the tenant vacates.

LOCATION, LOCATION, LOCATION!

Commercial properties are locations for doing business. It follows that a location that allows the proprietor to do more business more efficiently will be worth more to that proprietor.

Ease of access for customers, clients and staff will clearly make it easier to do business. So, access to public transport, major roadways and car parking all enhance a property’s value.

Car parking is particularly important for office and retail properties. On the other hand, properties well serviced by public transport will often get away with less parking – CBD properties being a good example.

Corner locations are always coveted due to exposure and ease of access and retail strips do better when they include banking outlets.

Another key Location issue is the vacancy rate for commercial properties in the surrounding area. A high vacancy rate will generally mean that it will take longer to lease out your property and your prospective tenants will be looking for concessions. Conversely, a low vacancy rate should mean that your property remains consistently occupied and you have a stronger bargaining position with your tenants.

LEASE COVENANT

Once you have acquired your investment property you will want to lease it out to an appropriate tenant.

Care should be taken in assessing the quality of your prospective tenants and the structure of the lease agreement that you enter into.

The calibre of your tenant is important but you should also assess how their use compares with other surrounding businesses. If it is too different there may be no natural customers in the area and if they are too similar they may suffer from an overly competitive environment.

Key features of a good lease structure are having a good tenant in a long term lease at a strong rental. However, you should also pay particular note to the following features:

  • Type and frequency of rent reviews (CPI or fixed percentages)
  • Is the rental fair and sustainable? The frequency of market reviews is important (ideally prior to each option and midterm if the initial term of the Lease is longer than 7 years)
  • Security offered by the tenant (bank guarantee or personal guarantees)
  • What is required of the tenant when they vacate (makegood clauses) 

Inclusion of Demolition clauses if the property has development potential (see below)

DEVELOPMENT POTENTIAL

A property has Development Potential when it can potentially generate a greater total return after a demolition and re-development than it could have in its original state.

Usually this means knocking over a smaller, older building and replacing it with a larger modern building that uses the property footprint more efficiently.

A property with development upside will normally sell on a lower yield because of the potentially higher capital return achievable after the re-development. It is essential in assessing the Development Potential of a property to have an understanding of relevant zoning and planning restrictions and what size development the property can sustain.

Existing lease arrangements should also be thoroughly reviewed for any term provisions that would allow the tenant to remain in place frustrating plans to re-develop.

STAMP DUTY & GST

When calculating your potential yield, capital gain and total return you should include in the cost base the government imposts of Stamp Duty and GST. Generally speaking, when you buy Victorian commercial property you will be liable to pay Stamp Duty and GST may be payable depending on a number of factors regarding how the sale is structured.

Assessing the applicability and quantum of these taxes can be a complex exercise and your GormanKelly Commercial Property Consultant will be happy to assist.

COMPARABLE RECENT SALES/ LEASING EVIDENCE

Regardless of the asking price, the true market value of a property can only be determined by examining comparable sales and leasing transactions. In a commercial property market the size of Melbourne there is a constant stream of transactions involving a wide variety of properties. This results in a deep database of information on values, yields, occupancy rates and growth rates.

Be sure you do your homework before you make your move.

This Commercial Property Buying Guide is intended as a brief guide only. Obviously, each property offers a unique opportunity and should be assessed on an individual basis.

GormanKelly would be delighted to assist you with the process of purchasing, managing or selling your commercial property. Take a look at how we can support you by clicking on the button below.

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Aldo Galante

Written by Aldo Galante

For over 30 years, Aldo has been at the forefront of Australia’s fast-evolving property industry. He served as President of the prestigious Australian Property Institute (Vic), providing determinations on rent-reviews and valuations

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