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Home Understanding commercial property
May 1, 2024

An introduction to property valuations

Cromwell’s Investment Manager, Lachlan Stewart, is an experienced commercial real estate professional, who has spent more than 20 years working for highly respected organisations, including Colliers International and GE Capital Real Estate. He specialises in property valuations and financial modelling.

The importance of valuations

Section 601FC(1)(j) of the Corporations Act imposes an express obligation on a commercial property owner to ensure that the scheme property, which includes any real estate, is valued at regular intervals appropriate to the nature of the property. A company can decide to internally value or externally value a property.

As such, a commercial property valuation is the most reliable way of determining the market value of an income-producing property – it serves as an important, professionally backed tool for owners, investors, banks, regulators, and other interested parties.

Unlike residential property, commercial properties can be complex in the way that they are valued, given that every commercial opportunity is driven by a different set of needs and unique contributing factors. These factors will be explored in greater detail below.

Types of valuations

External valuation services

To undertake a property valuation of an asset, building owners engage external, independent commercial property valuers. These valuers generally:

  • are independent of the property owner
  • are authorised to practice as a valuer
  • have experience in valuing properties like that owned by the property owner
  • are registered or licensed in the relevant state, territory, or overseas jurisdiction in which the property is located
  • subscribe to a relevant industry code of conduct in the jurisdiction where the property is located
  • should have no conflict of interest in relation to the valuation.

Internal valuations

In some instances, building owners may choose to conduct an internal valuation. A company’s Board may value a property itself where, in its reasonable opinion, it is not necessary or not practically possible for a valuation to be obtained from an external valuer. This valuation type typically uses the same methodology and metrics as independent, external valuations.

Commercial property valuation is the most reliable way of determining the market value of an income-producing property – it serves as an important, professionally backed tool for owners, investors, banks, regulators, and other interested parties.

How properties are valuated

There are two main methods of valuation that are routinely applied to the asset valuations in Australia – the income capitalisation approach and the discounted cash flow approach. It should be noted that there are other methods of valuation, but, for the purposes of this article, we will examine these two most common methods.

Income capitalisation approach

The income capitalisation approach to property valuation examines the net income a property would achieve in an open market – regardless of whether it is leased or vacant – divided by the appropriate capitalisation rate, to give the core value of the asset.

The capitalisation rate (cap rate) (yield) is the component that moves with market forces, such as interest rate changes, economic growth, vacancy rates, inflation, and lease covenants. The capitalisation rate is similar to the price-earnings multiple, often used when valuing shares. Valuers will also look at the capitalisation rates of comparable sales over the previous 12 months when calculating the market value of an asset.

In example 1 consider a property, which produces income of $100,000, is capitalised at 6.0% – the market value would be $1,666,666.

If, due to market forces, the capitalisation rate tightened to 5.0%, and the income remained the same, the market value of the property would increase as per example 2.

Example 3 demonstrates if the capitalisation rate rose to 7.0%, and the income remained the same, the capitalised value would decrease.



As you can see, market value moves inversely from capitalisation rates.

Once an asset value is determined, valuers can adjust for certain variables.

For instance, the valuers would make an adjustment for how much the current tenants are paying, compared to what the market rent of that property should be. Likewise, there would be adjustments made for any discount or tenant incentives that a building owner is applying to that space for the duration of those tenants’ leases.

As part of this approach, valuers also look forward over the immediate horizon – which might be anywhere between 12 and 36 months – to consider any near-term lease expiry and will make an adjustment to reflect the costs associated with that downtime and re-leasing. They will examine whether there is any vacant space, as well as the costs associated with leasing that space out.

Valuers also look at any capital expenditure (capex) considerations that there might be. For example, if there’s a broken lift, and it’s estimated that $5 million will be required for a replacement, adjustments will be made to the core value, to end up with the market value. That value is applied to a point in time – “as at” the day of valuation.

Discounted cash flow approach (DCF)

More assumptions are involved in a DCF when compared to the income capitalisation approach – including the target return or discount rate, rental growth, lease expiry allowances, renewal probability, capital expenditure, and a hypothetical sale profit– but it has the potential to provide a more accurate picture of the cash flow horizon over a longer period.

Using this method, valuers typically forecast a 10-year cash flow, with a hypothetical sale profit at the end of year 10. All the income over 10 years is discounted back to a present-day value at an appropriate discount rate. An exit terminal value at year 10 (for the hypothetical sale, using an appropriate terminal yield) is also discounted to a present-day value. To derive the net present value of the property, it becomes the sum of the discounted property cash flows and the discounted terminal value.

Determining an appropriate discount rate

To determine an appropriate discount rate, a comparison is made with returns from alternative investments, the most common comparison being the 10-year government bond rate, as it is considered ‘risk-free’ and matches the investment horizon. A premium is then applied to reflect the risk of a property investment when compared to the ‘risk-free’ rate.


Adjustments are made within the 10-year cashflow. For example, consider a multi-tenanted building. Realistically, not all tenants are going be there for the entirety of that 10-year horizon – so, these lease expiries are factored into existing lease cash flows.

The valuer considers what happens when each tenant’s lease expires, applying a renewal probability of that tenant remaining (or leaving) and applying associated costs for potential downtime, capex to refurbish the space and the costs associated with re-leasing (leasing fees, incentives, etc.).
If an expiry is in six years, for example, the valuer has an informed opinion of what the market rental should be as at today, and then they’ll apply a growth rate to get to the market rent at that point in time. They’ll also apply a tenant incentive and will have a hypothetical lease term at that point in time.

So, the valuer is making a lot more assumptions here than what they would do in a capitalisation approach – but they’re also getting a longer horizon of cashflows to look at.

Capital markets can also influence cap rates. If a particular asset class or sector becomes more desired, the price investors are willing to pay per unit of income will increase and vice versa.

Contributors to a property’s value

The two biggest contributors to determining a property’s value are: a) the net market income it can deliver; and b) the appropriate rate of return. An appropriate rate of return is the appropriate “multiple” or risk premium to apply to the income (like price-earnings) considering asset and market-level risk factors.

Both the net market income and the rate of return are affected by property and market-level considerations.

Property characteristics

There are all kinds of property characteristics that contribute to determining an asset’s value. This includes the physical and locational characteristics of the land itself – for instance, an office building in the middle of the Sydney CBD is going to be worth more than that exact same building and lease profile in a metropolitan or regional market.

There are several additional factors that are important, including access to transport, amenity, natural light, and physical characteristics of the building. The desirability of the building for tenants is important to consider – for example, in a residential context, properties on Sydney Harbour or Brisbane River are worth more than those away from the waterfront. For commercial property tenants, proximity to customers and suppliers is also important, as are end-of-trip facilities; operational efficiency/sustainability; design and ambience; and floorplate layout.

And then there is the tenant occupied characteristic – is a leased building worth more than an unleased building or a vacant building? Usually, the answer is that the leased asset has a higher value. Other factors, including weighted average lease expiry (WALE) are factored into the valuation – longer WALE is usually valued more highly, due to the security of the income and lack of capital expenditure (capex)/downtime assumptions. Spaces occupied by blue-chip tenants and government departments are generally valued more highly, due to the security underpinning the lease.

Similarly, costs associated with the property also come into consideration – a building that requires a heavy amount of capex is generally going to be worth less than a building that’s just had a large amount of capex spent on it.

Market conditions

Broader market conditions also play an important role in determining asset values at a point in time. As explained above, movement in the ‘risk-free’ rate influences the appropriate risk premium to be applied to a property’s cashflow, and is affected by interest rates, inflation, and other financial and economic conditions.

Surging inflation and higher interest rates have been a major driver of recent cap rate movements, with the cash rate target increasing by 4.25% since March 2022, and the 10-year government bond yield increasing by 1.69% over the same period. This has led to a similar rise in cap rates, in order to maintain the typical ‘spread’ between the risk-free rate and property. The table below highlights the shift using New South Wales/Sydney as an example.


Property Avg Equivalent Yield Prime CBD Office Outer Central West Sydney Industrial NSW Regional Shopping Centres NSW N’hood Shopping Centres 10y Gov Bond Yield
Mar-22 (%) 4.44 3.26 5.13 5.13 2.50
Dec-23 (%) 5.69 5.25 6.00 6.25 4.19
Change (bps) 125 200 87 113 169
Spread to Gov Bond (bps) 150 106 181 206 na
Historical (25y) Avg Spread (bps) 184 310 200 340 na


Uncertainty regarding the future can also be an influence on cap rates. This has been exemplified by office valuations, where the impacts of hybrid working on office space demand are yet to be fully understood. While some of the potential impacts may be reflected in rental growth assumptions, some may be reflected in the cap rate as a general measure of higher risk.

Capital markets can also influence cap rates. If a particular asset class or sector becomes more desired, the price investors are willing to pay per unit of income will increase and vice versa. This was seen over the last five years across the industrial sector. Institutional investors in particular viewed the sector more favourably than had been the case historically, contributing to a greater weight of capital pursuing an allocation – the magnitude of the capital shift outpaced the ability of the market to supply new stock, leading to higher valuations.

In summary

In the face of fluctuating markets, a commercial property valuation is the most reliable way of determining the representative value of Cromwell’s income-producing assets. As a business, we adhere very closely to the methods outlined above to provide investors with clear and accurate information on each of our assets. Cromwell will continue to provide transparency about the valuation process – and how our properties are valued, as the information is generated.

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Home Understanding commercial property
June 1, 2023

A guide to tax-deferred distributions

Property real estate income funds can be an attractive investment for those people seeking a reliable source of regular income. Most of this income comes from rent earned on the fund’s underlying properties and, as rent is usually paid monthly, a property fund is able to pay distributions monthly or quarterly, which is an advantage for an investor’s personal cash flow. At times, some of the income from property funds may include a component of “tax-deferred distributions”.

Due to their complexity, however, tax-deferred distributions are rarely understood by anyone outside professional investor or tax specialist circles.


Tax-deferred distributions occur when a fund’s cash distributable income is higher than its net taxable income. This difference arises due to the trust’s ability to claim tax deductions for certain items – such as tax decline in value on plant and equipment; capital allowances on the building structure; interest and costs during construction or refurbishment periods; and the tax amortisation of the costs of raising equity.

In tax technical terms, tax-deferred amounts can give rise to distributions from property trusts of “other non-attributable amounts” for trusts that have elected to be Attribution Managed Investment Trusts (AMITs) and “tax deferred” components in non-AMITs – all referred to as tax-deferred distributions in this article.

Tax-deferred distributions are generally non-taxable when received by investors. Instead, these amounts are applied as a reduction to the tax cost base of the investor’s investment in the property fund, which is relevant when calculating any Capital Gains Tax (CGT) liability upon disposal of the investment units or once the tax cost base has been reduced to nil. Therefore, any tax liability in relation to these amounts is ‘deferred’, typically until the sale or redemption of an investor’s units in the fund when CGT may arise.

At its simplest, tax deferral works as follows: suppose a trust earns rental income of $100 and has building allowance deductions of $20. Then the net taxable income is $80, which is distributed to unitholders to be included in their taxable income. The remaining $20 of cash is distributed to the unitholders too, but for tax purposes it is regarded as a reduction in cost base of the units invested in the fund by the unitholder.

So long as the accumulated tax-deferred income is less than the investor’s acquisition cost, the tax is generally able to be deferred. If tax-deferred amounts have reduced the cost base to zero – that is, if the investor has received total tax-deferred distributions at least equal to the original cost of the investment – then any excess must be declared as a capital gain in the year it is received.

Capital gains are distributed by a trust only when the trust sells capital assets at a tax profit. These gains are then subject to tax in the investor’s hands, the same as other gains. Alternatively, investors are taxed on any capital gains, including any accumulated tax-deferred distributions, when they dispose of their units in a trust or the trust is wound up.


An incidental benefit of tax-deferred distributions for investors is the ‘deferral’ of tax until a CGT event, such as when the sale of your units or the wind-up of the trust, triggers a CGT liability.


Tax-deferred distributions reduce the investor’s cost base for CGT purposes, thereby increasing the CGT gain upon realisation. If the investor holds the units for more than twelve months, they may be able to significantly reduce the tax payable by applying the 50% discount for individuals, or by the one-third discount for superannuation funds.


Tax-deferred distributions may also be reinvested until such time as a CGT event occurs. The compounding benefit from reinvesting these distributions can be significant over time.

Case Study

The case study below shows the effect of tax-deferred distributions for an investor on the top marginal tax rate (assumed to be 45%). The case study compares a hypothetical $100,000 investment into an interest-paying investment earning 5% per annum with a property investment paying 5% distributions.



As you can see, an investor on a marginal tax rate of 45% and entitled to a 50% CGT discount makes a tax saving of $3,375.


Assumptions used in the case study:

  • An individual investor invests $100,000 into XYZ Investment (for example, an unlisted property trust) in Year 1 at a cost of $1.00 per unit (XYZ Investment).
  • The XYZ Investment is redeemed in Year 4 (i.e., after three years) at a unit price of $1.00.
    No allowance has been made for any potential capital gain or loss from unit price increases or decreases during the period the investment is held. This would also have CGT implications.
  • Distributions from XYZ Investment are 100% tax-deferred for the full period of the investment (in order to illustrate the potential savings).
  • XYZ Investment distributes 5.0 cents per unit, per annum.
  • The investor does not have any capital losses available to offset gains.




1. Capital gain = $100,000 capital redemption, less reduced cost base of $85,000 ($100,000 initial investment less $15,000 tax-deferred distributions = $85,000) = $15,000 capital gain. Tax payable = $15,000 x 45% x 50% = $3,375. The tax payable does not take into consideration any Medicare Levy surcharge.

This article has been prepared by Cromwell Funds Management Limited ABN 63 114 782 777 AFSL 333214 (CFM). The above information has been prepared for general information only and should not be relied upon as tax advice. This information should be read in conjunction with the Australian Taxation Office’s (ATO) instructions and publications. An investment in a property fund can give rise to complex tax issues and each investor’s particular circumstances will be different. As such we recommend, before taking any action based on this article, that you consult your professional tax adviser for specific advice in relation to the tax implications. This document does not constitute financial product or investment advice, and in particular, it is not intended to influence you in making decisions in relation to financial products. While every effort is made to provide accurate and complete information, Cromwell Property Group does not warrant or represent that this information is free of errors or omissions or is suitable for your intended use and personal circumstances. Subject to any terms implied by law which cannot be excluded, Cromwell Property Group accepts no responsibility for any loss, damage, cost or expense (whether direct or indirect) incurred by you as a result of any error, omission or misrepresentation in the information provided.

About Cromwell Direct Property Fund

Read more about Cromwell Direct Property Fund, including where to locate the product disclosure statement (PDS) and target market determination (TMD). Investors should consider the PDS in deciding whether to acquire, or to continue to hold units in the Fund.

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Home Understanding commercial property
September 5, 2022

Understanding the commercial property market


Australians’ love affair with, and focus on, residential property means that a whopping 68% of the average household’s total wealth is allocated to this one asset type1. Most investors will understand this lack of diversification increases risk and introduces volatility.

The defensive characteristics of property, however, are still very much in demand from yield-hungry investors and one option available to them is to consider commercial property as an alternative to their residential investments.

Property in your portfolio – beyond residential

Security of income from commercial property is generally higher than residential property due to the binding nature and longer term of commercial leases. Additionally, commercial tenants’ financial covenants are often superior. Commercial tenants are also often responsible for the majority of outgoing expenses whereas residential tenants are not, providing investors in commercial property with a higher percentage of rent received.

According to CoreLogic2, average rental yields for houses in Australian capital cities fell to a record low of just 3.1% in 2016, compared to commercial property yields of 6.3% for the year to 31 December 20163. Both types of property offer the potential for capital growth.

Like all investments, there are risks and traps associated with commercial property, and investors need to understand the characteristics of the asset class before committing.

Commercial property sub-sectors defined

Commercial property refers to all non-residential real estate and is divided into three main sub-classes – office, retail and industrial.

  • Large number of diverse sub-sectors
  • Wide range of grades of property, from premium quality office towers to basic suburban office blocks
  • Options include entire properties as well as strata floor plates and individual offices within buildings
  • Location varies from CBD, outer CBD, regional and suburban, also impacting on grade
  • Large number of diverse sub-sectors
    • Options for investment include large metro centres, regional centres, specialist retail hubs and individual assets
    • Locations vary from CBD to metro to regionals and suburban
  • Large number of diverse sub-sectors
    • Options for investment include large metro centres, regional centres, specialist retail hubs and individual assets
    • Locations vary from CBD to metro to regionals and suburban
  • Large number of diverse sub-sectors
    • Options for investment include large metro centres, regional centres, specialist retail hubs and individual assets
    • Locations vary from CBD to metro to regionals and suburban

Table 1: Features and General Return Profile of sub classes

Office Retail Industrial
  • Large number of diverse sub-sectors
  • Wide range of grades of property, from premium quality office towers to basic suburban office blocks
  • Options include entire properties as well as strata floor plates and individual offices within buildings
  • Location varies from CBD, outer CBD, regional and suburban, also impacting on grade
  • Large number of diverse sub-sectors
  • Options for investment include large metro centres, regional centres, specialist retail hubs and individual assets
  • Locations vary from CBD to metro to regionals and suburban
  • Sites are frequently custom-built/designed for specific tenants
  • Individual industrial properties vary considerably from one to the next
  • Lower barriers to entry than retail or office due to fact that properties are typically cheaper and quicker to construct
General return profile
  • Yields sit between retail and industrial
  • Yields differ substantially depending on the grade of the property (premium property is generally lower yield than lower grade properties for example)
  • Provides the lowest yield of the three core commercial sectors
  • Often requires greater capital expenditure (capex) than other sectors
  • In challenging economic times, non-essential retail can struggle
  • Provides the highest yield
  • Lower capital growth potential due to the fact that location is often outside of major centres
  • Specialist industrial properties can be difficult to re-lease if tenant leaves


Options for accessing commercial property

In general terms, investors have two options – they can buy a property directly themselves, or pool their money with others.

Direct investment can definitely pay big dividends – many a family fortune has been founded on the back of astute accumulation of commercial property, but for the majority of individual investors, buying and managing a commercial property is neither possible nor sensible. The high cost of most commercial property makes it financially out of reach, and maximising returns from a commercial property requires serious skill and expertise, which individual investors may not have.

Direct commercial property investment within an investor’s SMSF is becoming more common, in particular where members own commercial premises and look to transfer them into their fund. There are, however, barriers to this in the form of SMSF borrowing and contribution caps legislation, and it could also be considered questionable in terms of diversification where a person’s income and superannuation fund both rely on the one place of business.


1. Listed property (A-REITs) investment – property, in a liquid form
A-REITs were discussed in detail in our last issue, and the characteristics are examined briefly again as follows:

Benefits Considerations
  • Liquidity Professional management of the property portfolio
  • Small investment gives access to a large, diversified portfolio
  • Smooth income (yield) underpinned by commercial leases as well as the potential for capital gain when properties are sold
  • Reliable income levels – A-REITs must distribute at least 90% of their income to investors in the form of distributions
  • Income may be tax-advantaged due to the favourable tax treatment of property depreciation by the ATO
  • Transparency
  • Gearing levels (watch they are not too high)
  • A-REITs are subject to general market sentiment and movements (unrelated to the underlying property portfolio) and are closely correlated with equity markets
  • Do not provide as direct an exposure to property as an unlisted trust does
  • Do not provide significant diversification benefits to equities


2. Unlisted property – trading liquidity for a more direct property exposure
Unlisted property trusts are also known as property funds, syndicates, or schemes. They allow investors to buy units in a professionally managed trust which directly holds investment property or properties. Unlisted property trusts can be closed-end (fixed duration of usually 5-7 years) or open-end (no set duration with limited liquidity throughout).

Benefits Considerations
  • Potential for direct access to a high quality portfolio
  • Smooth, stable reliable income stream as 100% of rent (net of expenses) from the property portfolio is distributed to investors in the form of income
  • Income can be tax-advantaged due to the ATO’s favourable treatment of depreciation of property assets
  • Returns are closely linked to the underlying property assets and are less affected by general market movements than returns from A-REITs
  • Value is based solely on the valuation of the underlying assets, which generally occurs annually
  • Unlisted trusts are not highly correlated to other asset classes
  • Good hedge against inflation as lease payment increases are usually inflation-linked or have fixed increases
  • Initial investment in an unlisted trust is usually much larger than for an A-REIT, typically with minimums of $10,000 or more
  • Closed-end unlisted trusts are illiquid during the term of the trust and can be difficult, if not impossible, to exit the trust
  • Open-end unlisted trusts may offer some liquidity but investors need to understand the mechanics of the term or duration of the trust


The bottom line: commercial property is a valid alternative when investors have so much of their wealth tied up in the residential sector.

Commercial property investment has historically delivered attractive risk adjusted returns with an average (annualised) total return (inclusive of income and growth) of 11.0% over the last five years, 8.9% over the last ten years, and 10.5% over 15 years, up to December 2016, according to the MSCI All Property Universe Index (which is published by MSCI’s analysis of over 1,440 Australian commercial properties)3.

Whether purchasing commercial property directly or by pooling your funds with others and investing into REITs or unlisted property trusts, the benefits of investing into commercial property certainly should be considered within a diversified portfolio.



1. Australian Bureau of Statistics (ABS), Australian National Accounts: Finance and Wealth, September 2016, Release 5232.0
2. CoreLogic Hedonic Home Value Index, December 2016
3. MSCI IPD All Australian Property Index December 2016

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Home Understanding commercial property
June 5, 2022

Making sense of commercial property yields


In a low interest rate environment, commercial property continues to offer attractive opportunities for income-hungry investors. But what drives commercial property yields? How do they impact asset prices? And how are they affected by changes in interest rates and bond markets?

For investors seeking a reliable income stream, commercial property can offer very attractive opportunities; especially at a time when bonds and fixed income rates are at record lows.

In our article, Understanding the Commercial Property Market (Insight, Autumn 2017), we compared residential property yields with those of commercial property. The one year results favoured commercial property, with a yield of 6.3% in the year to 31 December 20161, in comparison with average residential property rental yields hitting new lows of just 3.1% in Australian capital cities over the same time frame2. As further comparison, Australian shares currently offer an average yield of around 4.2%3.

So, while commercial property yields have moderated along with other investment returns as interest rates have fallen, the sector still remains a leader on yield. This isn’t simply a coincidence. In many ways, yield is the key to the commercial property market, driving both investor behaviour and asset prices.

Yields, prices and cap rates
In the residential property market, price often drives yields, rather than the other way around. Spurred on by sentiment or the hope of capital gains, residential property buyers have recently bid up the price of housing to exceptional levels, even while rents have remained relatively static.

As a result, residential rental yields have fallen dramatically, to levels well below those offered by other asset classes. Despite today’s low interest rate environment, many residential property investments now generate yields lower than the cost of borrowing, leaving investors with a potential loss, unless they can later sell at a high enough price to recover their costs (the strategy known as negative gearing).

In contrast, negative gearing is not a strategy pursued by commercial property investors. Not only do commercial property investors generally seek higher yields to cover their cost of debt, they typically value properties based on the rental income they can generate — similar to valuing a business on a multiple of profit.

A key concept here is the capitalisation rate or cap rate. Calculated by dividing a property’s net rental income by its value, cap rates are widely used to assess and compare potential commercial property investments. As a result, the value of a property often depends on the yield that investors are willing to accept.

Let’s look at an example to see how it works:

Imagine an investor owns a building valued at $10 million which generates a net income of $700,000 per year.

As a result, the building’s cap rate is: $700,000 ÷ $10,000,000 = 7%.

Now suppose that the same investor has the opportunity to buy a second building, which generates a net income of $1 million a year. How much should they be willing to pay for it?

Assuming they want to achieve the same 7% cap rate as their first investment, they would value the new building at:
$1,000,000 ÷ 7% = $14.28m.

But if they were willing to receive a cap rate of only 5%, they would be willing to pay more – up to
$20 million ($1,000,000 ÷ 5%).

That’s important, because investors don’t make decisions about yields in isolation. Instead, they are influenced by a range of factors, particularly changes in interest rate settings and the yield offered by other investments, especially bonds. Which is why changes in interest rates and bond yields can impact commercial property prices so strongly.



1. MSCI IPD All Australian Property Index, December 2016.
2. CoreLogic Hedonic Home Value Index, December 2016.
3. ASX/S&P ASX200 dividend yield as at 12 May 2017. Source: Morningstar.

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Home Understanding commercial property
March 16, 2022

How can commercial real estate hedge against inflation?


Inflation can be detrimental to an investor as it chips away at savings and investment returns. Where inflation picks up, investors often turn to real assets such as real estate as a hedging strategy. Here, we outline a number of ways in which commercial property can act as a hedge to inflation.

Value increase for existing stock
An upside for investors is that inflation can lead to an increase in property values.

Rising inflation can lead to an increase in the cost of building materials for developments in one of two ways. First, should interest rates rise, it would lead to higher borrowing costs and resultingly, increases in the cost of building materials for developments.

Second, and most relevant in the current environment, supply constraints have made access to building material increasingly scarce, thereby driving prices up.

Both of these factors lead to new construction becoming increasingly less attractive or viable. As a result, this can limit the supply pipeline and increase the price for existing properties.

Value-add office strategies an alternative to new builds
According to JLL, demand and occupancy throughout the pandemic of modern, quality office stock has outperformed the market as COVID-19 has heightened awareness of health, safety and sustainability. As construction of new stock is strained, this will likely result in an uptick in value-add strategies to redevelop or retrofit older stock with a particular focus on occupant wellness.

Lease structure
Commercial property leases can include fixed annual rental increases, giving investors an income boost that offsets the effects of higher inflation. It is common for annual rent increases to be set above the long-term inflationary outlook, or even specifically tied to increases in inflation.

For example, a long-term lease to a government tenant in an office building might have annual rent increases structured at a fixed rate plus CPI inflation. For quality, well-located stock in an environment with heightened demand due to less stock coming to market, landlords are in a position to charge higher rent.

The downside is that if inflation is too high, it is harder for investors to capture rental growth at or above inflation, resulting in a hit to income streams.

Where are investors looking?
According to JLL, investment into commercial real estate across the Asia Pacific region is tipped to increase by 15% in 2022, after a 30% increase in 2021. As economic activity stabilises, travel restrictions continue to lift and employees return to cities, office investment is tipped to increase by between 20% and 30% this year.


Higher quality assets with lower levels of vacancy, often leased on long-term deals to government, listed and blue-chip tenants will continue to curry favour with investors due to their ability to provide access to regular, reliable income through market ups and downs.

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Home Understanding commercial property
October 6, 2021

Future-proof your commercial property portfolio

Chris Hansen


Real estate offers investors an opportunity, not available in other types of assets such as bonds or shares, to add additional value to their original investment through asset development, refurbishment or enhancement initiatives.

For investors who do not want to just ‘buy the market’ building, refurbishing or improving property can be expensive, but done smartly, it can be well worth the capital outlay. Indeed, as markets run hot, now is an opportune time for property owners to look at development opportunities in their portfolios.

Why develop?
There are a number of benefits that accrue to the various stakeholders within the development process. Developments can help revitalise local areas and neighbourhoods, provide jobs before, during and after construction, and the economic benefits can spread up and down the supply chain.

Private investors investing in a development or asset enhancement initiative will usually only proceeds when they believe the opportunity will provide them with an appropriate risk-adjusted return.

While the level of return each may seek will be bespoke to their particular situation, the return for commercial office development is generally realised through the delivery of a higher quality asset, in a good location, supported by improved amenity which in turn will attract a strong, or stronger, tenant covenant. The asset is then valued based on the security of this income over the duration of the hold period and eventually the development profit when it’s sold.

Workplaces drive change
Workplaces were evolving even before COVID-19. The pandemic has simply accelerated the process and many tenants are proactively reviewing their future office requirements, from location to amenity and the design and use of space as well as sustainability, wellbeing and health and fitness benefits.

To attract and retain quality tenants, landlords need to continue to provide versatile and well-managed environments that allow tenants to maintain a positive workplace culture while balancing work-from-home arrangements and facilitating the safe return of employees to the office.

Enhanced technology is a critical factor for improving building services infrastructure and operations and the customer experience of the occupants. Properties that can better service tenants’ requirements will be more desirable, allowing them to secure quality tenants and reliable cashflows than those that do not. This will make them more appealing to investors when the time comes to sell.

Managing risk
Development can be expensive but, with a good development strategy, the uplift in yield and capital value more than compensates for the cost.

An integrated approach to risk management is key. This requires expertise in development, project management and sustainability, as well as technical knowledge and skills and an in-depth understanding of what prospective tenants and the market are looking for. Being able to identify attractive locations and submarkets, down to specific streets and buildings, also helps minimise risk.

Cromwell’s redevelopment of 19 National Circuit, Canberra is a good example. With a 20-year history of investing in the ACT, Cromwell was comfortable progressing a development given the site’s location in the tight Barton market. The property is within close proximity of Parliament House and other key federal government agencies and opposite the National Press Club of Australia. There is hotel accommodation both adjacent to, and across from, the site.

Deep and ongoing working relationships with tenants are also invaluable. Understanding tenants’ changing requirements not only assists in retaining occupancy, it also provides opportunities to create value and informs development decisions.

Cromwell’s proposed development at 475 Victoria Avenue, Chatswood, which seeks to increase the precinct’s floorspace with an additional commercial offering and alternative to the existing commercial towers, has been heavily influenced by a rethinking of the modern workplace for the benefit of both existing and future tenants.

The end-of-trip facilities, as well as the heating, ventilation and air-conditioning (HVAC) system upgrade and office foyer refurbishment, in addition to the new commercial office development, have been designed based around key sustainability, safety and hygiene considerations.The project is targeting a minimum 5-Star Green Star rating, as well as a 5-Star NABERS Energy and Water rating. The development will be complemented by the planned Chatswood to Sydenham Metro Rail expansion due in 2024.

Understanding tenants’ changing requirements not only assists in retaining occupancy, it also provides opportunities to create value and informs development decisions.

A counter to inflation
A development strategy can also help commercial property investors future-proof their investment against inflation. Worldwide, inflation rates have been supressed by the effects of COVID-19, but many experts are forecasting above-average medium-term rates as countries emerge from the pandemic.

Real estate is a hedge against inflation. This is because commercial property leases can include fixed annual rental increases, giving investors an income boost that offsets the effects of higher rates.

Higher inflation also generally signifies increased economic activity, which can lead to increased demand for properties. Higher demand therefore allows landlords to increase rents, particularly if it comes at a time where there is less new construction, which can occur in such environments.

This is due, in turn, to the increase in costs of building materials, making development more expensive, therefore increasing risk in some cases, and ultimately influencing returns. When coupled with higher borrowing costs, new construction can become less attractive, although this does depend on the individual opportunity.

Take control
Investors who respond to changing tenant needs and actively seek to add value through development and asset enhancement initiatives can improve their returns, subject to a keen appreciation and understanding of market conditions. With current low inflation rates and borrowing costs, this is an ideal time for property investors to consider the development opportunities within their portfolios.

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Home Understanding commercial property
December 9, 2019

The essential guide to investing in unlisted property trusts

Property is one of the favoured investments of Australians due to its potential to provide both income and capital return. Its low volatility relative to other asset classes, such as equities, is a strong attraction.


The different property asset classes

Property is an asset class which is usually separated into two distinct groups – residential and commercial.

Residential property, which can include your own home, holiday home or residential investment property, is the most commonly held type of property investment by volume. Commercial properties are generally used for business purposes and are usually divided into four categories: retail, office, industrial and specialty.

The fundamental difference between commercial and residential property is that commercial property investments are generally made on the basis of yield. The value of a commercial property is based on the income return it will provide to an investor, which is known as the capitalisation rate. The value is affected by factors including the lease terms, quality of tenant and other building attributes.


Various methods to invest

There are a number of ways through which investors can gain exposure to commercial property, ranging from direct investment, private syndicates, pooled professionally-managed property trusts, ASX-listed real estate investment trusts (A-REITs), or unlisted property trusts.


Benefits of investing in an unlisted property trust

There are several benefits investors gain from investing into a commercial property trust:

  • Investors’ funds are pooled, providing access to assets they could not otherwise purchase individually, such as large office buildings or major shopping centres;
  • Internal gearing is non-recourse to investors, which means if there is a default, the issuer of the debt (usually a bank) can seize the collateral but cannot seek out the investor for any further compensation. This reduces the risk to each individual investor;
  • Regular income stream, with distributions ranging from monthly to six-monthly payments;
  • Investors share in any capital growth, proportional to their holding in the trust;
  • Potential for tax-deferred income, increasing investors’ after-tax return;
  • Professional management, covering due diligence, debt, property and tenant management;
  • Liquidity (dependent on the structure used); and
  • Only a small investment is required, allowing investors to more easily diversify across properties and managers.


How does an unlisted property trust work?

Unlisted property trusts provide an investment with characteristics most like a direct purchase of a commercial property, with the added benefit of professional management.

As unlisted property trusts are generally priced based on the underlying valuation of their property assets, their price volatility is a lot lower than A-REITs and the value of the investment is primarily influenced by movements in the commercial property market rather than by the broader share market.

There are two types of unlisted property trusts, open-end property funds and fixed-term, closed-end property trusts (often referred to as syndicates).

Open-end property funds

Open-end funds don’t have a maturity date or a finite number of units. Instead, they can continue to issue units so long as they raise money, using the new funds to purchase additional properties.

As there is no specific maturity date, to allow investors to exit the investment the fund must have some other method of liquidity. Liquidity is usually provided by holding a portion of the fund’s assets in cash, using new investors’ funds to pay out exiting investors, or selling assets if necessary. This can allow investors to exit at regular intervals.

As with A-REITs, these funds tend to have a number of assets to increase diversification, but it is at the manager’s discretion to buy or sell assets, so investors do not have certainty over the properties they are investing in.

Fixed-term, closed-end property trusts (syndicates)

Syndicates contain one or more properties that will be held for a specified period of time, usually five to ten years. At the end of the specified time, investors will vote on the future of the trust, with the default outcome usually that the property be sold, the trust wound up and investors paid out. Syndicates should be considered illiquid investments and you need to have an expectation that you will remain in the investment for the full investment term.

Market volatility has dramatically increased investor interest in simpler syndicate investment vehicles since the GFC. Syndicates provide a strong proxy for the direct purchase of commercial property. They are generally fairly easy to understand and you know for certain which property (or properties) are going to be owned. Therefore, if you don’t like the property, you simply don’t make an investment in that trust.

Single property syndicates don’t provide any diversification on their own, but because the minimum investment is generally as low as $10,000, you can combine investments in a number of syndicates to provide diversification by property, location, sector and manager.

Ideally, you would also choose syndicates with different maturity dates, so you are not reliant on the property market being strong at a given point in time.

Property management

A key reason for using an unlisted property trust is gaining the expertise of a property manager. The best property fund managers have an internal property management division which looks after the buildings in the trusts it manages. Having this function in-house ensures buildings are managed properly, and their capital value and appeal to current and prospective tenants is maintained.

Property management includes leasing, ongoing maintenance of buildings, building concierge services, fire safety and other compliance requirements and, most importantly for investors, making sure rent is collected! Investors pay for these services, but they will already be taken into account in the forecast distribution rates in the given trust.

Costs and fees

The trust will generally be charged acquisition fees, ongoing management fees, property management fees and various other fees by the manager depending on the individual trust, its assets and structure. The trust is also likely to pay stamp duty for the acquisition of properties plus legal and other costs.

Any returns forecast will take these fees and costs into account. ASIC requires all managers to display their fees and costs in a consistent format in the Product Disclosure Statement (PDS), which makes it easy to compare the fees associated with various unlisted property trusts.


The trust will receive rental payments from tenants and this is passed on, less the aforementioned expenses, to unitholders as distributions on a regular basis. Depending on the trust, distributions may be paid monthly, quarterly or six-monthly.


Getting out

Fixed-term trusts

These are essentially illiquid throughout their term unless you or the fund manager can identify someone to purchase your units. At the end of the trust’s term, the property is sold, the trust wound up and investors paid out proportionately to the units they hold.

Open-end funds

Each open-end property fund will have a different liquidity mechanism, but as the underlying property assets are illiquid, the ability to exit the fund will have limitations. Common ways of providing some liquidity is to hold some of the fund’s assets in cash, using cash from incoming investors or, if demand is high and market conditions allow, selling assets.


Reviewing an unlisted property trust

The manager of an unlisted trust provides you with a lot of information about the trust and its assets in the PDS, so it is important to read and understand it – particularly the ‘Risks’ section. Third-party organisations such as Lonsec and Zenith are also useful, as they provide a detailed review of the trust and its assets.

There are a number of additional aspects of a trust that are worth reviewing. These include the manager, distribution yield, property asset – inclusive of all the considerations within, such as location, building quality, growth, tenants, lease and green credentials – the trust structure, fees, borrowing and more.

For more in-depth information on this topic, download Cromwell’s Essential Guide to Investing in Unlisted Property Trusts at www.cromwell.com.au/essential-guide

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Home Understanding commercial property
December 18, 2017

Anatomy of a great commercial property investment

Patrick Weightman


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.

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.

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.