How To Own Commercial Property |

Within the term commercial property there are three main types of property for commercial investment property.  These types are classified basically by the use to which they are put.

They are:

• retail property, e.g. shopping centers, strip shopping, stand-alone shops
• office property, e.g. medical centers, professional office buildings, strata offices
• industrial property, e.g. factories, warehouses, workshops, distribution centres

There are other types of commercial property, still fairly well known but perhaps not as obvious at first glance.  These include:

• petrol stations
• restaurants
• hotel and motels
• parking stations
• storage facilities

There are also ‘composite’ properties that are categorized as commercial property.  These are properties that have more than one use, such as a building with a retail store on the ground floor and a residential apartment on the first floor.  In large cities you would notice even larger composite properties that include car parking, retail shops, serviced apartments, residential apartments and offices as part of the one composite property!

With residential property the governing logic is to meet the needs of people for shelter and to provide accommodation for the basic functions of human occupation.  With successful commercial property, the governing reason for the existence of such property is to fulfill the need for commerce and to meet a genuine need or demand for that property in that location.

In a country like Australia where there is a robust economy, there is a plentiful supply of investment funds looking for a home.  These funds will be invested where the investor can get a satisfactory financial return on invested capital - either as income or capital growth or a combination of both.  In other words, the investment meets a need.

This need will then be fulfilled in a logical manner in regard to the location of the commercial property, the type of the property, the size of the property, and the support facilities such as roads, power, etc.  Where these needs are met to a level that a tenant can see that he can occupy and use that building to generate his own profit, then that building achieves a rental stream.

That rental stream is the basis of value of any commercial property.

As with other investments, only rarely are these ‘logical’ reasons met 100% in any one instance.  It is this varying degree of ‘fit’ that determines the demand for that property and it is the demand for that property that determines its ultimate value.

For properties to follow this ‘logical’ plan of meeting particular needs, an overall governing plan is required.  That plan is formed with the influences of the 3-tiers of government – federal, state and local governments.

Such planning attempts to forecast and influence the use of land and the supply of supporting infrastructure such as water, sewerage, power, communications, etc. so that the future needs are aligned with the best use of these resources.

Again, in a perfect world these decisions will follow the logical pattern of meeting genuine needs.  You would have to be living in a dream world, however, not to realize there are two additional, powerful influences on where these resources are located and utilized.  These include the profit motive and the political influences.  Where these are used to excess or abused, the legal system of appeals can also have a real influence on the final outcomes.

These influences can be incredibly powerful in the eventual outcome.  A ‘canny’ commercial property investor would, of course, do their homework on what was happening nationally, in their state and in their local government district that would have a bearing on the planning laws and eventual planning decisions before making an decisions on commercial property investment.

There are two principal types of property – residential and commercial.

We all know that residential property is where people reside or live. Commercial property is where people work to earn their living, or carry on business or commerce.

While these two statements are an oversimplification, in very basic terms the statements do define property by their principal use or purpose.

Before moving on to develop the definition of commercial property, we would agree that there can be a commercial aspect to residential property. This, of course, is where residential property is acquired/constructed/used to fulfill a dual purpose:

i) to provide accommodation or a place to live for people who either need or prefer to pay rent for property owned by other people;
ii) to provide an income to the property owner from the rental income and to provide capital growth due to an increase in the value of the property over time.

In Australia the majority of residential property is occupied by people who own the property, i.e. the owner occupier. Nevertheless, a substantial proportion of residential accommodation is owned by investors as a commercial investment.

The term ‘commercial property’ is, however, generally accepted to mean property whose principal use or purpose is to provide a place where business or commerce is conducted. These properties have been constructed with that end use in mind.

The greater majority of commercial property is owned by investors and/or institutions which rent or lease the property to tenants who occupy the building as a facility in which they can conduct their own business for their own income/profit.

There is a lesser proportion of commercial property that is owned by owner/occupiers who have acquired/purchased a building that provides the facility they need to conduct their own business.

Some businesses are so specialized that the business owner has a specially designed building constructed to suit the special needs of that specific business, e.g. a building in which a highly toxic substance is being produced would demand stringent precautions and controls to be incorporated in the building. Such requirements cannot be fulfilled in a normal commercial building. Therefore a special building is required to meet those stringent requirements and this then is termed a ‘purpose-built building’.

Other examples of purpose-built commercial buildings include privately funded and owned prisons, private hospitals, etc.

Purpose-built buildings do not form a substantial part of the commercial investment property market.
Part 2 of “What is Commercial Property Investment?” coming soon.

Investing in commercial property has a number of advantages over investing in residential property. One of the main advantages is the lease terms. Commercial leases tend to be for longer terms. So, with residential property you might get a 6-month or a 12-month lease, but commercial properties can have 3- to 5-year leases, and even longer.
For a commercial tenant this is linked to the security of his business. If he has to relocate he cannot be sure his customers will follow him to the new location, so commercial tenants tend to remain longer than residential tenants.
For investors this can mean that even for a small commercial investment property, the income is secure for a longer period.
Rents paid by commercial tenants are also generally secured by a bank guarantee that stays current even if the tenant relocates and sub-lets his premises.
Another advantage of investing in commercial property is that growth is generally more certain because rent reviews are written into the lease. In many cases there is also a provision that when the rent is reviewed, it cannot be less than the rent for the previous year. This is very unusual in residential leases, whereas it is the norm in leases for commercial property.
With commercial property the expenses of operating the property, such as air conditioning, fire protection and security, are generally paid by the tenant. When increases in these costs occur they are also paid by the commercial tenant. This is quite different to residential property, where it is the landlord that pays. Where these costs increase and the landlord cannot pass them on, this effectively decreases the landlord’s profit margin.
When buying a commercial property you can usually get a loan up to 70-75 percent of the value of the property. When assessing your loan application, the lender places greater emphasis on the strength of the tenant and the security of the cash flow from the tenant’s business than on your own personal financial circumstances. This is a major advantage when you go to buy commercial property because your wealth creation is not tied to your own personal financial situation to the same degree as it is with residential property investment.
If the rent is not being paid, the remedies available to a commercial property landlord are much more in the landlord’s favor than the remedies available to a residential property landlord. For example, in certain circumstances non-paying commercial tenants can actually be locked out and their possessions sold to recover the debt. You would not normally find this with residential investment property!
Compared with some other forms of investment, such as artwork, gold, antiques, etc., investing in commercial property provides investors with both income and capital growth - in the same way as residential property. Historically, property has also provided higher long term returns than bonds and cash. In addition, there are significant tax benefits for commercial property investors - for example, depreciation allowances on building plant and equipment, such as air conditioning and security, and the structure of the building itself.
As with residential investment property it is possible to borrow against your commercial investment property. You can use this leverage to build a commercial property portfolio - if this fits within your investment plan.
Property is also a tangible asset – it is physical, unlike bonds and company shares. So with direct property investment you have a significant degree of control. This is not the case if you are an owner of shares, or listed or unlisted property entities, where you have little or no direct control over how your investment performs, as effective control is vested in the management agreement.

Rarely are the values of direct property investment subject to sharp and spectacular declines, such as can be the case with shares, or where properties form an asset of a collective ownership, such as company trusts, etc. The control is then vested in the board/management which has the power to pledge the assets as security to gain further properties or other investments not necessarily compatible with property. When this leads to financial over-commitment, it is the level and/or terms of borrowings, not the quality or performance of the property itself, that is the cause of the problem.
Another advantage of investing in commercial property is that you can add value to it. You can renovate, upgrade, subdivide, get development approval or change the use. There are more opportunities to add value to commercial property than there are to add value to residential property.
General investment advice is that you should not have all your eggs in one basket and should smooth out your investment returns, or reduce your investment risk, by having a spread of investments. This is another good reason to include commercial property in your investment portfolio. More advice on investing in commercial property to come.