A growing number of entry-level individual investors and family trusts are seeking to invest in commercial real estate, says Gareth Fraser, Auckland director of Colliers International's investment sales team.
"Surging capital values have priced many residential investors out of the Auckland housing market, making commercial property an appealing and affordable alternative," Fraser says.
"In the last 12 months we've seen a surge in inquiries from investors who would have previously invested in residential property. Until recently, these investors would have considered commercial property to be out of reach due to residential property still being relatively affordable.
"However, massive capital value growth in recent years has pushed median house prices well over $1 million. By comparison, entry level commercial units can be bought for as little as $300,000."
Fraser says that, along with the lower cost of entry, prospective investors are attracted to the competitive yields that commercial property investments can offer.
"As Auckland's residential capital values increased, residential rental yields didn't keep up, driving yields to 2-3 per cent in some cases," he says.
"Commercial yields have also tightened, but not to the extent of residential yields, with yields on premium properties usually in the 4-5 per cent range for retail and industrial, and 6-7 per cent still achievable for offices in some locations."
Loan-to-value restrictions on residential loans have also made commercial property more appealing, by bringing borrowing in line with commercial leverage in many cases.
Fraser says three commercial property sectors in particular are becoming popular with investors:
1. Commercial property syndication – a type of proportionate ownership in which investors own one or more shares in a large office, industrial or retail property. The minimum cost per parcel can be as low as $50,000, with projected returns of up to 8 per cent a year.
2. Unit titles – small retail, industrial and office units that form part of larger developments with unit owners paying body corporate fees for the management of a complex. Because they are generally smaller than standalone properties, unit titles are often affordably priced.
3. Freehold standalone properties – among the most sought-after investments but usually priced at higher values than syndications or unit titles.
Fraser says residential property investors contemplating an entry into commercial property need to appreciate that commercial is more sophisticated than residential.
Factors that need to be considered include:
• Lease documents for tenanted commercial property are longer and more complicated than residential leases so good legal advice needs to be sought by entry-level investors.
• Leases for commercial properties are usually for longer periods than for residential properties; and it can often take significantly longer to find a suitable new tenant for vacant commercial space in comparison to vacant residential space.
• Building integrity is an important factor for commercial property and the types of construction used are often different from residential properties requiring thorough due diligence to be undertaken on the building fabric and earthquake strength.
• The strength of tenant covenant - or the ability of the tenant to meet rent payments and lease requirements - needs to be considered; and whether there are any personal or bank guarantees available in the event of a default on the lease.
• The rental of a commercial property needs to be carefully considered in the context of the market norm to ensure a tenant is not overpaying; and, in the event of a tenant default, to ensure a property can be re-leased at the same rental.
However, Fraser says the complexity of investing in commercial property hasn't deterred entry level investors.
"We anticipate inquiries for affordable commercial property investments will increase with the recent slowdown in residential sales; and while the commercial market remains strong with attractive yields," he says.