Commercial Property Characteristics and Value

Nov 2, 2021 | Finance

Commercial property is used for business activities, or to generate a profit through the collection of rental income or capital gain.

It can be in many forms. This includes office buildings, hotels & motels, medical facilities, retail shops and shopping centres, farm land, warehouses and storage facilities…

 What’s the difference with Residential Property?

1) The Positives

Longer Lease Profile

The average lease for a commercial property is much greater than residential, measured in years rather than months.  As a result, commercial tenants tend to offer greater stability and certainty of income.

Tenant support for Outgoings

Commercial tenants typically cover outgoings such as council and water rates, insurance, body corporate fees etc.  Some laws will prohibit passing on “expenses that do not benefit the premises” but they can be passed on more readily than residential.

Value stability relative to other Asset classes

Relatively speaking, there has been less price fluctuations in commercial property values.

Tenant supported Asset improvements

Tenants are more likely to make improvements to the structure and layout of a commercial property, which can be beneficial to its value in the longer term.

2) The Risks

Commercial property is not without risk. So always consider:

Vacancy Periods

Commercial properties run the risk of being untenanted for extended periods of time, the lead times can be extensive in finding a suitable tenant. This means covering expenses during this period.

Exposure to the Macro Economy

A very obvious point right now, especially during the COVID crises.  The resultant economic downturn, weak business conditions or high unemployment may mean that there is less demand for commercial property.

Maintenance Costs

Yes, whilst your tenant may make some improvements to the property, the cost of upgrades when things breakdown, especially for a larger retail or office site, can be really expensive compared to other asset classes.

What tool can I use to measure my commercial property value?

Understanding the “Cap Rate”

The capitalisation rate, more commonly called the “cap rate”, is defined as the ratio of net operating income to the property’s value.  Whilst it does not represent a detailed analysis of the property investment risks, the cap rate is a useful industry ratio and it can be helpful in comparing different investment options.

Looking at cap rate trends can give you insights into the direction of valuations.  

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