What is Commercial Property?

Commercial property is used specifically for business or income-generating purposes. It has the potential to provide rental income as well as capital appreciation for investors. The longer-term lease length compared to residential renting, gives the real estate holder considerable cash flow stability, as long as tenants occupy the building.

The four main types of commercial real estate are:

• office space
• retail
• industrial
• multipurpose rentals

Maintaining commercial real estate rentals requires full and ongoing management by the owner. The rules and regulations governing such property vary by state, municipality, industry, and size. Most investors in commercial real estate either have well-informed knowledge or a payroll of people who do. Property owners may find it best to employ a professional valuation company like commercial valuation in Darwin followed by a commercial real estate management agency to help them find and retain tenants, oversee the financing, and manage property maintenance and marketability.

What Valuation Approach is Used for Commercial Real Estate?

The income valuation approach is the most frequently used technique when it comes to valuing a commercial real estate asset. It is based on how much income a property is expected to generate in the future. It is achieved by the algebraic manipulation of the formula:

Value = Net Income / Capitalization Rate

This method is used because, unlike residential properties where nearby home prices will be an indicator, it can be very difficult to find similar commercial properties in the same location. These expenses will depend on the type and age of the property. An older site will require more repairs and maintenance thus increases in costs, hence a lower NOI and a lower property value. If it is a new-build property, the value will be based on the 'expected' annual income.

If you are considering purchasing a commercial property, a valid lease, a detailed income, and expenditure for the advertised property can be asked from the seller. If this information is not available from the seller, the valuation can still be based on information available in the real estate market.

Other commercial valuation approaches are:

Cost per Rentable Square Metre

Here, the rentable area combines the usable area (the space tenants can occupy) with the common areas tenants benefit from, such as stairwells and elevators.

Sales Comparison Approach

Otherwise known as the market approach. This technique relies heavily upon recent sales data for comparable properties.

Cost Approach

The widely used method considers the cost of rebuilding the structure from scratch. It takes into account the current value of the associated land as well as construction materials and other costs that would be associated with the replacement of the existing structure.

Value per Gross Rent Multiplier

GRM valuation compares a property’s potential valuation by taking the price of the property and dividing it by its gross income.

Value Per Door

Mostly used for apartment buildings rather than single-unit structures. This method determines the entire building’s worth based on the number of units.

Income Capitalisation Approach

Based primarily on the amount of income an investor can expect to derive from a particular property. This could be a comparison of other similar local properties, combined with an expected decrease in maintenance costs.

There are four primary types of commercial property leases. Each requires a different level of responsibility from the landlord and the tenant:

• A single net lease makes the tenant responsible for paying property taxes.
• With a double net (NN) lease, the tenant is responsible for paying taxes and insurance.
• A triple net (NNN) lease makes the tenant responsible for paying property taxes, insurance, as well as maintenance.
• With a gross lease, the tenant only pays rent, and the landlord pays for the building’s property taxes, insurance, and maintenance.

To calculate which lease approach would be best, a rent review could be arranged in advance.

Pros and Cons to Consider when Investing in Commercial Property

Investing in commercial property can be an exciting venture for many investors seeking to diversify their portfolios and capitalise on potentially higher returns. However, like any investment, it comes with its own set of advantages and challenges. Below is a breakdown of the Pros and Cons to consider helping investors make informed decisions and navigate the complexities of this asset class.

Pros of Commercial Property

1. Higher income potential: Commercial Properties typically generate higher rental income compared to residential properties, especially if leased to businesses or corporations.
2. Longer lease terms: Commercial Leases often have longer terms than residential leases, providing more stable and predictable income streams for investors.
3. Diversification: Commercial real estate offers diversification benefits for investors looking to spread their investment across different asset classes reducing overall portfolio risk.
4. Professional tenants: Commercial tenants are often businesses or corporations with established operations and financial stability, reducing the likelihood of default or late payments.
5. Value appreciation: Well-located and well-maintained commercial properties have the potential for value appreciation over time, providing capital growth to investors.
6. Triple et leases: In certain commercial property types, such as triple net leases, tenants are responsible for paying property taxes, insurance, and maintenance costs, relieving the landlord of these financial burdens.

Cons of Commercial Property

1. Higher initial investment: Commercial properties generally require larger initial investments compared to residential properties, which may pose a barrier to entry for some investors.
2. Market volatility: Commercial real estate markets can be more volatile compared to residential markets, influenced by economic conditions, industry trends, and geopolitical factors.
3. Vacancy risk: Commercial properties may experience longer vacancy periods between tenants compared to residential properties, especially during economic downturns or in less desirable factors.
4. Complexity and management: Managing commercial properties can be more complex and time-consuming than residential properties, requiring knowledge of leasing laws, property management, and tenant relationships.
5. Tenant turnover costs: When tenants vacate commercial properties there may be significant costs associated with finding new tenants, renovating the space, and covering any downtime without rental income.
6. Market liquidity: Commercial real estate can have lower liquidity compared to other investment assets, making it challenging to sell properties quickly if needed, especially during market downturns.

Assess the Risks with a Commercial Property Valuation

While investing in commercial properties offers attractive income potential and diversification benefits, it also comes with higher initial costs, management complexities, and market risks that investors should carefully consider before making investment decisions.

With the constant change in the economy and society being inevitable, we advise thorough research for real estate investors to base their commercial investment decisions not only on the latest social trend but also to think about whether this particular business genre will survive through deflation. Is it a necessity for the community even in a financial crisis? If not, is it still worth risking?

We take every client’s valuation needs into consideration to offer the best possible commercial appraisal as a solution. Feel free to request a free, no-obligation quotation with us today or for any further advice and recommendations.