AUSTRALIA’S RESIDENTIAL property market is, by all accounts, booming. But can the same be said for the commercial property market?
The commercial property market is so large and with so many subsectors that you can’t apply a broad brush when talking about its performance, says Steve Palise, Owner and Buyers’ agent at Palise Property.
However, he says the commercial sector in the sub $5 million range is a “quiet boomer”, but for different reasons to the boom in the residential market.
“There is a huge undersupply of stock,” he says. “This, combined with record low interest rates, more awareness of the commercial sectors, a years’ worth of investors who did the ‘wait and see’ during COVID-19, and extremely low yields in the residential sector has made buyers flock to commercial property for known returns through positive cash flow as opposed to growth speculation.
“This has resulted in a 20 to 30 per cent increase in property values in this price range over the past four months.”
What are the strongest performing sectors?
The industrial sector has been the strongest performing sector in the commercial property market for some time, particularly since the COVID-19 pandemic began, due to an increase in ecommerce and a greater need for logistics.
Industrial vacancy rates are extremely tight in capital cities, says Palise.
“The industrial sector will prove to be the best moving forward.
“Industrial rents will increase due to low vacancy rates, low interest rates, and extremely high demand due to the e-commerce boom.
“Businesses are more than ever requiring industrial floor space for fast online distribution orders.
“Rising industrial property returns are now outperforming the office sector and gaining more attention from investors.
“Affordable industrial markets such as Brisbane and Perth have performed better due to very attractive yields of six per cent plus.
“For investors this sector is the easiest to analyse with steady data from square metre rates and vacancy periods, as well as the most versatility from a future tenant perspective.”
But Palise says suburban retail has also been performing well, which can also be attributed to the pandemic.
“The new working from home culture has meant retail in non-CBD locations has flourished, such as cafes, barber shops, nail salons and take away shops.
“Many of these businesses flourished during non-lockdown periods in the late part of 2020 early 2021.”
What about the office market?
Also due to the pandemic, the office sector has been the poorest performer in commercial property as a result of the huge increase in working from home, says Palise.
This has led to higher vacancy rates – and uncertainty about how many people will return to the office in the future.
Palise says workplace occupancy increased in the first quarter of 2021 as businesses looked to find their new normal, but that doesn’t mean vacancy rates have tightened, as almost no office occupiers are looking at expanding their footprint.
The containment of the pandemic and rollout of the COVID-19 vaccine will play a huge part in the timeframe for businesses to return to normal and determine their space requirements, he adds.
“Many businesses are looking to adopt the ‘hub and spoke model’ which means having a central office in the CBD and periphery offices in the smaller metropolitan areas.
“They will also look at reducing office floor space as many workers now work two to three days from home.
“There will be Increased demand for smaller office space with increasing vacancy for larger properties.”
Palise says overall there has been an increase in office enquiry due to business waiting for leases to finish and then looking at options moving forward into the future, often into smaller locations.
But he says there is a lack of overall rental growth expected in the office sector.
CBD rents are expected to fall due to oversupply, while minor CBDs and middle/outer ring offices will tighten due to increased demand with the hub and spoke model being adopted by most large offices, and suburban office rents will tighten.
“Soft rental growth is anticipated as tenants will use the lack of government incentives and a weak tenant demand as a bargaining tool. Occupiers will negotiate hard to gain the most favourable rent and lease term outcome.”
In the office market, Perth, Brisbane and Adelaide will be the stronger performers due to muted supply, while in Sydney and Melbourne new supply is still flowing through, which will increase vacancy rates, according to Palise.
Palise says retail CBD rents are also expected to fall as a result of lower foot traffic resulting in the increase of working from home, but suburban retail rents will tighten due to higher demand.
Should you buy into the commercial market?
While there are big benefits associated with investing in commercial property, careful selection of assets and thorough due diligence is always critical.
“Buying a bad residential property in a mediocre suburb means you will typically just need to make the difference in payments from the rent and mortgage repayments, whereas with commercial you could have a vacant property for years,” Palise says. Interest in commercial property is currently coming from both domestic and offshore buyers, with high cash flow and far superior returns to the residential market being the biggest drawcards, says Palise.
He says an investor can achieve a passive income quite quickly, and returns typically range between five to eight per cent net.
“Commercial yields are net and not gross because the tenant is usually responsible for all the outgoings on the property.
“A $500,000 commercial property is typically $25,000 a year cashflow positive after all expenses, whereas a $500,000 residential property will have a negative cashflow – or just neutral.”
Other benefits for commercial property investors include long tenancies, more value-add opportunities, and an opportunity to diversify outside of residential property.
If you do by a commercial property don’t forget to order a depreciation schedule here.