Commercial Property: Is It the Right Investment for You?

None of this makes commercial property automatically better. It's a different beast, with different income, risks and lending rules. For some investors, it's a smart way to diversify. For others, the bigger price tag and reliance on a single tenant won't stack up.

Let’s break down how commercial property works, and what you need to know before a lender will back you.

What makes commercial property different?

Commercial property is leased to businesses, not families. Think offices, shops, warehouses, medical suites and mixed-use buildings.

The lease is everything. It spells out rent, term, rent reviews, outgoings, renewal options and responsibilities. The building, location, lease and tenant's ability to pay all affect the property's value.

Why investors consider commercial property

Higher rental yields

Commercial property can deliver higher rental yields than residential. Recent data indicates:

Commercial property therefore offers an indicative gross yield of around 1.6 to 3.1 percentage points more than a Melbourne residential house, but yield doesn't tell the whole story. Longer vacancies, leasing costs, tenant incentives and maintenance can quickly eat into returns.

Before buying, consider:

• Vacancy risk

• Property management and leasing fees

• Rent-free periods or incentives

• Repairs, capital works and insurance

• The tenant’s financial position

Longer leases

Commercial leases typically run for several years, often including renewal options. That's great for income visibility and can make your property more attractive to lenders and buyers.

But the remaining term matters. Eight years left on a lease is very different to 12 months. Check rent reviews, renewal options, break clauses, assignment rights and make-good obligations before committing.

Commercial lease lawyers can review the lease before you sign, particularly where it includes complex outgoings or make-good obligations.

Tenants often cover outgoings

Depending on the lease, your tenant may cover some or all outgoings, including council rates, water, insurance and repairs.

But don't assume everything’s passed on. It depends on the lease, property type and state or territory rules.

Diversification

If your portfolio is heavy on residential property, commercial property spreads your risk across different tenants and pockets of the economy.

Just don't mistake diversification for risk-free. Commercial property is less liquid than shares, usually needs a bigger deposit, and can be tougher to offload if vacant or niche.

Not all commercial property is created equal

Lenders and buyers treat asset types differently. A property with broad appeal will attract more interest than something niche with a small tenant pool.

Industrial and warehouse properties in established areas can have solid demand. Office space needs a closer look at vacancy rates and shifting demand. Retail depends on location, foot traffic, tenant mix and lease strength.

Medical premises often have a specialised fit-out and established tenants, but a narrower resale market. Hospitality venues and development sites carry extra risk: trading performance, planning approvals, operator experience and construction costs.

How banks assess commercial property

Getting commercial finance isn't just about your income and credit score. Lenders dig into the property, the lease and the tenant too.

They'll typically assess:

• Your overall financial position, debts and serviceability
• The loan-to-value ratio (LVR) you’re after
• Whether it’s owner-occupied or an investment
• Asset class, location and property value
• How easily the property could be sold
• Tenant strength and remaining lease term
• Rental income and outgoings

A leased industrial property in a good location is likely to be assessed differently from a vacant office or property with little lease term remaining.

How to buy commercial property: who's funding it?

It’s not all about the property. Banks and lenders want to understand the borrower, guarantors, and take a holistic review regarding the financial viability of the potential property acquisition.

Major banks tend to prefer established assets with a strong tenant, decent location, long lease and conservative gearing.

Second-tier banks and specialist lenders can be more flexible where your property or ownership structure doesn't fit a major bank's policy.

Non-conforming lenders may consider unusual properties, complex income or rocky financial history. But that flexibility can come at higher rates, lower LVRs, extra fees or more frequent reviews.

Commercial finance brokers can help compare lender appetite, commercial property loans and the cost of each option. The cheapest advertised rate isn’t always the right fit.

Commercial property loans: LVR, rates and fees

Your LVR is simply how much you're borrowing against the property's value. The lower the LVR, the more equity you need.

Your equity needs to stretch further than the deposit. You’ll need to consider budgeting for stamp duty, legal and valuation costs, loan establishment fees, repairs or fit-out, leasing commissions and working capital.

Commercial interest rates are assessed on a case-by-case basis. Lenders will consider factors such as the property, LVR, tenant, lease terms and your overall financial position.

Banks have become more flexible with commercial lending in recent years, with some transactions potentially able to be funded up to 100% of the purchase price, depending on the broader circumstances. For some major banks, an LVR of around 80% has become more common for loans below approximately $2 million. However, an LVR of around 65% will generally provide access to the most competitive rates in the market.

There are fees to consider too, including:

• Establishment fees
• Valuation and legal costs
• Annual review fees
• Account or line fees
• Loan admin fees
• Break costs
• Early repayment or exit fees

Some loans come with interest-only periods, others require principal and interest from day one. Know your loan term, review dates and refinancing requirements before signing.

Is commercial property the right investment for you?

Before you jump in, ask yourself:

• Who’s the tenant, and how financially solid are they?
• How much lease term is left?
• Are the rent reviews realistic?
• Who pays for what?
• What happens if the property goes vacant?
• Can you manage the required equity and a period without rent?
• Which lenders are likely to back this asset?
• Has the property been independently valued?
• Does the investment fit with your broader investment strategy?
• Is the ownership structure appropriate for your circumstances and long-term plans?

Commercial property can offer a different income mix and diversify your portfolio, but it’s not set-and-forget. Review the property, tenant, lease and funding structure first. It’s also important to speak with your financial adviser to ensure the investment aligns with your broader investment strategy, and your accountant to determine the most appropriate ownership structure and manage the tax implications.

Considering commercial property?

BlueRock’s commercial finance brokers can help you understand your lending options and get the funding structure right. For advice that considers your broader circumstances, we also recommend speaking with a BlueRock financial adviser and accountant. Get in touch via the form below.

Disclaimer: The information in this article is intended as general information only and should not be considered as advice on any matter and should not be relied upon as such. This information has been prepared without taking into account any individual objectives, financial situation or needs. You should therefore consider the appropriateness of the information before acting or seek advice before making any financial decisions.