Anatomy of a great commercial property investment
The right commercial property investment can deliver strong and sustainable returns over the long term, but not every property has the same potential. Here are seven key features to look for in a stand-out property.
What makes the perfect commercial property investment? The truth is that there is no single right answer. A great deal depends on your investment strategy and the role each asset is destined to play in a larger portfolio – whether as a core income generator or an asset that can be transformed over time to create added value.
Nonetheless, successful investments do tend to have key features in common – features that can only be uncovered by disciplined analysis of each asset’s fundamentals. They all impact asset returns, even when the return hurdles differ between asset types.
Here are seven of the most important features:
1. High quality tenants
Given the role income plays in commercial property returns, finding the right tenants is the first and most important consideration. A reliable tenant, such as a government agency or a sizeable business with a healthy balance sheet and strong cash flow, is the single best guarantee of your future income. They represent the lowest risk in terms of being able to meet their lease obligations and the highest probability of resigning leases due to the cost to them if they relocate. If a property is multi-tenanted, rather than a single-occupancy asset, high-quality tenants can also attract other reliable tenants.
2. Attractive facilities
Tenants are not just attracted by the look and feel of a building. It must provide the services they expect, like functioning lifts, adequate lighting, good air conditioning and a quality fit-out (to name just a few). Beyond expectations of basic services, tenants will be attracted to properties which meet their specific needs. If the location isn’t easily accessible by public transport, more car parking spaces or private transport options (like a regular shuttle bus) will be required.
Adding green infrastructure, like solar power, permeable pavements and green roofs, whilst requiring higher initial capital investment, can reduce outgoings and increase the value of the asset. Meeting a tenant’s green credentials is another way to attract stable, long-term tenants who can only occupy properties which meet their organisation-wide standards.
If sufficient capital has not been set aside to bring the building up to expected standards, and then maintain it, this can have a negative impact on the long-term return of that asset.
3. An appealing location
A property has to be in a location where it can attract and retain tenants to generate the underlying income required. However, that doesn’t mean you should only focus on city centres, or assets in high-density areas. A diversified portfolio is likely to include assets in CBD, metropolitan and regional locations.
Outside of the CBD, regional locations tend to offer more car parks at a lower rate, lower occupancy costs and larger floor plates that support greater workplace efficiencies. Regional locations may also meet needs unique to employment providers in the local area.
CBD locations often have significantly higher land and building costs plus high incentives to win leases. These can all cut into profit margins.
4. The right leasing structure
Most commercial property investors know that a property’s WALE, or “weighted average lease expiry”, can be an important indicator of the security of future cash flows. A higher WALE indicates that tenants (weighted by either rental income or lettable area) are locked into their leases for some time to come. Though long leases with fixed rental increases can provide stability, they may not always deliver the best returns over the life of the asset.
When demand is exceptionally strong, an asset with a short WALE can potentially allow you to reset new or renewed leases at a rate higher than would have been available through fixed rent reviews of either 3% or CPI. Nonetheless, short WALEs do have obvious downsides. They include the capital cost of resetting leases, which can be substantial – especially in markets like Perth and Brisbane, where high tenant incentives are common.
5. The potential for repositioning
A property with tenant vacancy can still be a good investment, as long as you understand the reason for the vacancy and how it can be repositioned to attract new tenants. In fact, assets that offer scope for repositioning can be highly valuable additions to a portfolio, with the potential to improve both yields and valuations through enhanced rental income. Having a vision, knowing your potential tenants and knowing how to reposition an asset to meet both market and tenant requirements is where experience really comes into play.
6. Financial analysis
While leases can be structured so that the tenant pays part, all or none of the outgoings, it’s still important to have a clear understanding of all the outgoings over the life of your investment. Every dollar spent on the asset reduces your potential return, unless it clearly increases the property’s appeal, and thus, it’s long-term value.
If a vendor estimates $1 million in annual outgoings, but your analysis suggests a figure closer to $1.5 million, that difference can have a significant impact on the profitability of the investment – which is why thorough due diligence on a property is absolutely essential.
Equally important is an analysis of the capital expenditure required to maintain, improve or position the asset so it can achieve the rents as forecast.
7. Compatibility with your investment strategy
Finally, but perhaps most importantly, it’s important to assess whether an asset fits your portfolio’s overall asset mix as well as an informed market outlook. For example, an investor with a well-established portfolio might consider a low-cost refurbishment and repositioning opportunity in a location that has unrealised future potential; whereas an investor seeking a core holding might prefer
a proven income-generator in an established area.
Taking a disciplined approach
Finding the right investment takes discipline. An analytical framework that helps identify successful investments and a thorough analysis of each property’s fundamentals can help you effectively make your money ‘on the way in’ to a long-term investment.