Article update 7 September 2021.
For many commercial property investors, return on investment (ROI) is the main driver of their investment decisions. So how do you identify and achieve a strong ROI on a commercial property?
Achieving ROI on commercial property comes down to identifying opportunities, doing your due diligence and being comfortable with a degree of risk, says Shaun Venables, partner at Burgess Rawson.
“In today’s market, buyers are more concerned about security and capital preservation,” he says.
So how do you have your cake and eat it too?
“Many investors try to tick every box in relation to commercial investment strength – from location to yield and tenant and lease terms. But if return alone is your focus, you may need to think outside the square.
“In many respects, return on investment is a barometer of risk – the greater the risk, the greater the return required.”
Less than perfect can be… perfect
Many commercial property investors look for the ultimate combination of a high-profile tenant on a long lease with favourable terms – including the tenant paying outgoings – and fixed yearly rental increases.
Yet even if a commercial property doesn’t tick every box, it can still deliver above-average returns to shrewd investors, according to Venables.
“Perhaps the lease on the property is due to expire, which might deter a large percentage of investors,” he says. “But if your research indicates a strong likelihood that the tenant will renew the lease, your purchase could pay off considerably.
“When the tenant takes up its new lease, you are much more assured of strong competition and a firmer yield, at which point you should be well placed to realise a capital gain.”
Look beyond your own backyard
Commercial properties in metropolitan areas tend to come with a higher price tag, yet Venables says strong returns can also be achieved on properties located in regional areas.
“Again, it’s about doing your homework and understanding the market you’re buying into,” he says. “Some commercial investors are currently steering away from regional bank branches, for example, with concerns around closures.
“Yet there are bank branches in regional areas that may make prime investments, principally because if the catchment population is big enough and isolated from competition, their location means the likelihood of closure is highly unlikely.”
Venables says commercial properties in regional areas – such as well-located medical or retail premises – can perform just as strongly as similar properties in metropolitan areas, yet the purchase price can be considerably less and the yields higher.
Consider your choice of asset
Different types of commercial properties fall in and out of favour with the market. Having the courage to go against the grain can generate significant returns for the cool-headed commercial investor.
“Childcare centres are a great example,” Venables says. “A few years ago, investors were very concerned about these properties, but today childcare centres are in high demand, the lease terms are investor-friendly and they can offer some very strong lease covenants.
“Similarly, petrol stations went through a stage of being very unpopular. Now, with some major brands on modern, well-regulated sites, the market is very keen on this property sector and they are commanding higher prices.
“If you can spot an asset class that others are not so keen on, but which has the potential to perform strongly, you can achieve above-average returns. Obviously, there is a degree of risk in this type of approach, but if it pays off, the rewards are there.”
Extended vacancy is a sure-fire road to cash flow depletion, reduced (or negated) ROI and capital erosion – not to mention sleepless nights. You have a better chance of avoiding vacancy if you choose a more versatile commercial property that can be easily re-leased, according to Venables.
“A well-located supermarket is the ultimate trophy investment in terms of minimal risk of vacancy, and these properties are always in high demand.
“If your appetite for risk is a little greater, you will find even higher returns in industrial property, but may face greater challenges if you need to find a new tenant.”
Use data to explore the market
The commercial property market is incredibly diverse, and it can be hard to compare apples with apples when selecting a high-performing investment to add to your portfolio.
CommercialRealEstate’s sophisticated search function enables buyers to compare properties based on type, location, price (total or per square metre), annual return, occupancy and more. Boost your chances of making a good commercial investment decision with the right data at your fingertips.