Why smart money is moving into commercial property
Office and retail property has struggled, however as we start to see a push from corporates to return to the office and with more interest rate cuts on the way, strong tailwinds are forming.
The Reserve Bank is expected to cut rates next week, with more cuts tipped to follow.
With each rate cut, income-focussed investors warm to the idea of transferring funds out of cash investments in an attempt to boost falling levels of interest. And it is not just income investors sniffing about, bargain hunters are also out in force looking to secure assets with strong capital growth potential at bottom of the cycle prices.
Commercial property has been out of favour since the pandemic but is now experiencing a U-turn recovery. Broken down into three segments - office, industrial and retail - each have experienced their own unique ups and downs but are all broadly following the same upward trajectory.
Global accounting firm KPMG released an assessment of the commercial property market and are far more upbeat than a year ago.
“The downturn in the Australian commercial property market has appeared to have made a U-turn, with two out of three key sectors now recording positive returns,” KPMG said.
“The office sector returns remain negative but has appeared to have bottomed out. We maintain a degree of optimism about the long-term demand for commercial property.”
If we think about the work from home trend borne from the pandemic it is little surprise that industrial properties have performed better than their office and retail property counterparts. Warehouses were in high demand during Covid as consumers shifted their preferences from physical shopping to purchasing online. But the toll of rising interest rates finally hit the warehouse sector in late 2023 and property prices fell until a recovery started earlier this year.
Office and retail property has struggled, however as we start to see a push from corporates to return to the office and with more interest rate cuts on the way, strong tailwinds are forming. For retail property, a lack of stock and the potential for mixed-use retail and residential developments in the future has buoyed the sector. For offices, prices are still falling but appear to be bottoming out.
In terms of income levels, you can expect to achieve a gross rental yield of 6.5 per cent for retail, 5.5 per cent for office and just under 5 per cent for industrial. Compared with term deposit rates, which are currently below 4.5 per cent and likely to drop into the mid to high 3 per cent range by the end of the year, commercial property is starting to look attractive.
When it comes to capital growth, office property presents the biggest opportunity and astute buyers can purchase good quality offices at pre-Covid prices. When it comes to where to buy, Sydney-based buyers agent Kitty Parker from Kitty & Miles feels the old saying of location, location, location rings true.
“There will always be demand for prime CBD real estate in major capital cities such as Sydney, Melbourne and Brisbane. As you cannot create more land in the middle of a city, the only way to keep expanding is to go up and this provides an opportunity for investors to buy in low rise strata buildings and sell to developers down the track” Parker says.
How much will I need?
You do not have to spend millions to get your hands on a warehouse, office or retail investment. Entry level commercial properties start below $500,000 and are priced per square metre, meaning the bigger the building, the more expensive the price tag.
“It is possible to buy a ‘B’ or ‘C’ grade 40sqm office suite in Sydney CBD for less than $500,000,” Parker says.
A popular strategy for medical and professional service business owners has been to purchase a commercial property inside of their self managed super fund and rent it back to themselves. Having done this myself, I can attest to the benefits of this approach.
Utilising superannuation for something that provides an immediate benefit is appealing while still remaining compliant with all the superannuation rules and regulations. You enjoy the stability of being your own landlord and also have access to up to $2m in capital gains tax free profits after retirement, from age 60.
Investors do need to keep in mind that commercial property is different to residential property and GST is payable on the purchase price if there is not an active lease in place at the time of settlement. Banks also lend less on commercial property compared with residential property and overall vacancy rates tend to be higher.
It is no secret that conditions have been tough, first with the pandemic and then with rising interest rates. However, recent data shows that times are changing and some believe that we may be at the beginning of a purple patch for commercial property.
James Gerrard is principal and director of financial planning firmwww.financialadvisor.com.au
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