Is Melbourne commercial property a good investment?

Australian households have more than half their wealth in residential property. It’s easy to understand and familiar. This makes it the investment of choice in our country, particularly in Melbourne where the residential property market is strong and performs consistently. However, it’s more important to diversify your investments.

Commercial property is an option that serious investors should at least consider. That said, investing in this asset class can be a little more complex and it’s essential that you know what you’re doing.

The advantages of commercial property investment

Investing in Melbourne commercial property can be even more rewarding than residential. Here are a few of the most compelling reason why:

• Commercial properties are generally higher yielding. In fact, residential investments in Melbourne yield between 2 and 4 per cent. Whereas with commercial it’s not uncommon to find yields of between 7 and 9 per cent if you buy well and pick the right location.
• There’s potential to add value. It’s possible to find commercial properties where considerable value can be added through renovations and improvements. However, these properties may be lower yielding.
• Commercial tenants pay most of the investment’s outgoing costs. That means your tenant could be paying rates, insurance, maintenance and perhaps even body corporate fees.
• Some tenants may modify or improve your property to suit their business, increasing its value.
• Commercial leases are generally longer and tenants are often more reliable. One-year leases are common in residential properties but commercial leases are generally between two and 20 years long.
• Annual rent increases are written into most commercial property leases so that your investment income growth matches or exceeds inflation.
• Your property’s value will increase as its rent does. This means if you add value to the property after buying, or secure a high-paying tenant on a long lease, you could also enjoy higher capital gains.

While commercial property can be more involved and complex than residential, these advantages mean it’s worth considering for those looking to diversify.

The risks and drawbacks of commercial property investment

Commercial property isn’t a risk-free investment. However, if you’re well aware of the potential pitfalls it’s far easier to make decisions that help you minimise and avoid them. To make sure your eyes are open, here are some of the drawbacks of commercial property investment:

• Commercial properties may have a higher risk of vacancy. The property council recently reported that vacancy rates for Melbourne CBD offices are the lowest of any in the country at 10 per cent. Residential property in Melbourne has a far lower vacancy rate of 1.6 per cent, according to SQM research. If you do happen to lose your commercial tenant these numbers prove they can take a bit longer to replace.
• The commercial market is sensitive to changes in the economy and interest rates. If the economy is performing poorly and interest rates rise, vacancy rates may increase and commercial property values may fall. This means it’s important you don’t stretch your financial limits when buying.
• Your property’s value may decrease if the rent does. If you incur a vacancy during a quiet period in the market and have to cut your asking rent, or settle for a lower quality tenant this could hurt your property’s value – since it’s tied to the rent and quality of the tenant.
• A larger deposit may be required. While you may be able to buy a home with a 20 or even 10 per cent deposit, you’ll need between 30 and 50 per cent to buy commercial.

The key to avoiding these risks is picking a quality property that matches your investment goals and securing a long lease with a quality tenant.

If you’re new to commercial property it’s essential you take time to understand what makes a quality asset. You need to do your homework, speak to local experts and develop a thorough understanding of the market in the area where you’re buying.

To get you started, here are the main things you need to look for in a commercial property:

• Quality location: This is the most important factor when choosing an investment. It should be close to transport links, amenities and residential hubs. What’s more, depending on the type of investment you buy you’ll need to consider other factors. For example, a retail shop should generally be somewhere with good foot traffic nearby similar outlets.
• Good condition: Fitting out or repairing a commercial property can be vastly expensive. When you buy it may be smart to look for something in good condition that’s ready to be used right away to avoid these costs.
• Zoning: Check with local authorities to find out what the building is allowed to be used for.
• Versatility: If a property is able to be used by several businesses in different industries it’s less likely to experience long vacancy periods.

The risk might be higher with commercial property, but the fact is the benefits can be too. To make sure you invest well, get in touch with the commercial team here at Nelson Alexander. We’ve been selling commercial property in Melbourne for decades, so we know the market better than most and we’re always happy to help.