Investing in a commercial property allows you to generate income from business tenants, which is to say such property could be an office, warehouse, retail shop, medical suite, childcare centre or another property used for business purposes.
For investors, the financing works differently from a residential investment loan. Lenders pay closer attention to the property itself, its location, lease, tenant, remaining lease term and how easily the property could be sold or leased again.
This means choosing a commercial property and choosing how to finance it often need to happen together.
What Is Commercial Property Investing?
Commercial property investing means purchasing real estate primarily used for business or commercial purposes, usually with the intention of earning rental income and potentially benefiting from capital growth.
The investment is commonly structured in one of two ways:
- You buy a property and lease it to an unrelated business.
- Your business buys or occupies the property while you retain ownership through an appropriate ownership structure.
The first is a traditional commercial property investment. The second is commonly referred to as an owner-occupied commercial property, even though the property itself could still form part of the owner’s wider investment strategy.
This distinction matters when you apply for finance. A lender assessing a tenanted investment property will usually want to understand the lease and rental income. An owner-occupied application places greater emphasis on the financial position and trading performance of the business occupying the property.
Types Of Commercial Investment Property
The type of commercial investment property you purchase affects the tenant market, lending options, valuation and amount you might need to contribute. Common property types include:
Offices
These range from small strata offices to larger office buildings. Location, parking, public transport, building quality and local vacancy rates can influence tenant demand. Lenders will also consider whether the office has a standard layout that another business could readily use.
Retail Property
Retail commercial property includes individual shops, shopping-centre premises and other properties occupied by retailers or hospitality businesses.The quality of the location and tenant can have a major effect on the investment. Foot traffic, surrounding businesses, parking and local competition can also influence demand.
Industrial Property
Warehouses, factories, workshops and logistics facilities fall into this category. Investors often need to consider access, ceiling height, loading facilities, zoning, building configuration and proximity to transport infrastructure.
Medical And Healthcare Property
Medical centres, consulting rooms and other healthcare premises are another commercial investment category. The property’s fit-out and permitted use matter because highly specialised premises might appeal to a smaller pool of replacement tenants.
Specialised Commercial Property
Hotels, motels, service stations, childcare centres, pubs and other purpose-built properties can require specialist finance. A lender might treat these differently from a standard office or warehouse because the value can depend more heavily on the property’s specialised use or the business operating from it.
A useful distinction for investors is between a property that happens to have a specialised tenant and a building that is physically specialised. The second can create greater resale and reletting risk if few other businesses could use the premises without substantial alterations.
Benefits Of Investing In Commercial Property
Commercial property investment appeals to investors looking for rental income and exposure to a different part of the property market.
Potential benefits include:
- Investors can diversify beyond residential property.
- Some leases require tenants to pay specified property outgoings.
- Commercial leases are often longer than residential tenancy agreements.
- Lease structures can provide greater income certainty while a suitable tenant remains in place.
- Commercial properties can produce attractive rental yields relative to some residential investments.
- Business owners might use commercial property ownership as part of a longer-term wealth or business strategy.
The lease needs as much attention as the property.
A property with an established tenant and several years remaining on its lease presents a different investment proposition from an identical building with a lease ending shortly after settlement. The headline rent alone does not show that difference.
Risks Of Commercial Property Investing
The main risks are vacancy, tenant concentration, financing costs, property-specific risks and reduced liquidity.
Longer Vacancy Periods
Finding a new commercial tenant can take longer than finding a residential tenant, particularly for properties suited to a narrow range of businesses. An investor relying heavily on rent to meet loan repayments needs enough financial capacity to manage an extended vacancy.
Tenant Risk
A long lease has less value if the tenant cannot meet its obligations. Investors should assess the tenant, lease terms and security arrangements rather than relying on the remaining lease term alone.
Property Specialisation
A highly specialised property can have fewer potential buyers and tenants. That issue matters to lenders as well. If a lender considers the property difficult to sell, it could restrict the loan-to-value ratio (LVR) or apply different lending conditions.
Interest-Rate And Refinancing Risk
Commercial loans do not always have the same loan terms, pricing structures or refinancing options as residential mortgages.An investor should consider what happens at the end of the loan term rather than assuming the existing facility will continue indefinitely.
Concentration Risk
A single commercial property might depend entirely on one tenant. If that tenant leaves, rental income could fall to zero until the property is leased again. A multi-tenanted property spreads this risk but introduces additional lease and management considerations.
Commercial Vs Residential Property Investment
Commercial and residential properties generate rental income, but the investment and lending models differ.
| Factor | Commercial Property Investment | Residential Property Investment |
|---|---|---|
| Tenant | Business | Individual or household |
| Lease | Often longer and more detailed | Usually shorter |
| Vacancy | Can take longer to fill | Generally has a broader tenant market |
| Outgoings | Tenant may pay specified outgoings under the lease | Many ownership costs remain with landlord |
| Finance | Commercial lending criteria | Residential investment lending criteria |
| Property assessment | Lease, tenant and marketability can heavily influence lending | Borrower serviceability and residential security remain central |
| Valuation | Often influenced by rental income, lease and comparable commercial sales | Primarily residential comparable sales and market conditions |
The financing difference is easy to underestimate. A residential investor might begin with their income, expenses and borrowing capacity and then search within that budget. With commercial property investing, the property selected can have a stronger influence on the finance available.
Two commercial properties with the same purchase price do not necessarily support the same loan amount. Their location, use, lease, tenant and marketability could lead lenders to assess them differently.
How Much Deposit Do You Need For A Commercial Investment Property?
There is no single deposit requirement for every commercial investment property. The amount you need depends on the lender and the security being purchased.
Factors that can affect the maximum LVR include property type, location, purchase price, property size, lease terms, tenant profile, whether the property is vacant, whether it has a specialised use, your financial position, and the lender’s commercial property policy.
This creates an important difference between your deposit and your total cash requirement.
You also need to account for purchase costs such as stamp duty, legal fees, valuation costs and other transaction expenses that apply to the purchase.
Before committing to a property, it helps to have the proposed security reviewed against commercial lending criteria. The amount a lender is prepared to advance can change once it knows exactly what property you intend to buy.
How To Finance A Commercial Investment Property
A commercial property loan is the standard financing option for a commercial investment property. The application usually requires information about both the borrower and the property.
Depending on the transaction, a lender could request:
- Current lease
- Contract of sale
- Property valuation
- Rental information
- Evidence of income
- Details of the tenant
- Details of existing debts and assets
- Tax returns and financial statements
- Personal or business financial information
- Trust or company documents where relevant
Commercial property lending is less standardised than residential home lending.
A property that sits outside one lender’s preferred criteria might fit another lender’s commercial policy. The difference could relate to the security type, location, lease, borrower structure or the way the lender assesses servicing. This makes lender selection part of the financing process rather than something to consider only after an application is declined.
What Do Lenders Look For In A Commercial Investment Property?
Lenders assess the borrower and the commercial property being offered as security.
Their assessment commonly includes:
Property Type
Standard offices, retail premises and industrial properties can be treated differently from specialised securities.A lender wants to understand how readily the property could be sold if it ever needed to recover the debt.
Location
A commercial property in an established market with a broad pool of buyers and tenants generally presents a different security risk from a highly specialised property in a small regional market.
Lease
The lender might review the remaining lease term, options to renew, current rent, rent-review provisions, tenant obligations, property outgoings, as well as vacancy status. A lease expiring soon after purchase could receive more scrutiny because the current rental income might not continue for long.
Tenant
The lender could consider the tenant’s business and the stability of the rental arrangement.
For an investor, this is also an important distinction. A long lease and a strong tenant are separate characteristics. Both need to be assessed.
Marketability
Lenders consider what would happen if the property had to be sold. A building designed for a wide range of businesses is generally easier to understand as security than a highly customised property with few alternative uses.
Borrower’s Financial Position
A strong commercial property does not remove the need to assess the borrower. Income, existing debts, assets, liabilities, credit history and the proposed ownership structure can all affect the application.
Is Commercial Property A Good Investment?
Commercial property could suit investors who understand the additional risks and have enough financial capacity to manage vacancies, property expenses and changes in financing costs.
The investment should be assessed on the individual property rather than the asset class alone.
Before purchasing, examine:
- Net rental income rather than rent alone
- Lease expiry and renewal options
- Tenant quality
- Local vacancy conditions
- Potential replacement tenants
- Property outgoings
- Maintenance and capital expenditure
- Financing costs
- Purchase and selling costs
- Property marketability
- Your ability to service the debt during a vacancy
Yield also needs context.
A high yield could reflect strong income, but it could also indicate that buyers are pricing in greater vacancy, tenant, location or property risk. Comparing yield without examining why the market has priced the property that way gives an incomplete picture.
The same principle applies to borrowing. The maximum amount a lender offers is a financing decision, not an indication that the property is a suitable investment. Consider
obtaining independent financial, legal, tax and property advice where appropriate before proceeding.
How To Get Started Investing In Commercial Property
Start with your investment position before making an unconditional offer.
Work out how much cash you have available.
Include your intended deposit and enough funds for acquisition costs and an appropriate cash buffer.
Establish your borrowing position.
Commercial borrowing capacity depends on your financial circumstances and the proposed security. An initial assessment gives you a starting point, but the final lending position can change once you select a property.
Decide which commercial property types fit your strategy.
Consider tenant demand, lease structure, vacancy risk, location and how much management the investment requires.
Review the lease before buying a tenanted property.
Check the rent, expiry date, options, reviews, outgoings and tenant obligations with your solicitor or conveyancer.
Check the property against lender requirements.
Do this before committing unconditionally where possible. A property being acceptable to you as an investor does not automatically mean it will be acceptable security to your preferred lender.
Arrange the appropriate due diligence.
Depending on the property, this could include legal, building, valuation, lease, zoning, environmental, tax and financial checks.
Compare commercial property finance options.
Commercial lending policies vary. Compare the loan structure and lender’s appetite for the property rather than focusing on the interest rate alone.
Home Loan Experts can assess your proposed commercial investment property and compare commercial lending options based on your circumstances and the security you plan to purchase. Speak with one of our mortgage brokers on 1300 889 743 or complete our free assessment form to discuss financing a commercial investment property.