Commercial Yields are Higher. Here's the Catch.

In this episode

Why advertised residential and commercial yields aren't comparable

What commercial property includes beyond CBD office towers

The one equation behind every commercial valuation

Six differences from residential that change how you invest

Why commercial property works inside a self-managed super fund

Five traps that catch residential investors

Where the sensible opportunities sit for private investors now

One practical move to make this week

The yield gap

A residential property advertised at 4% is closer to 2.5% once the landlord pays council rates, insurance, strata and management. On a properly structured commercial lease, the tenant pays those outgoings, so a 6.5% yield is close to what you keep.

The one equation

Commercial value = net income ÷ yield. A shop leased at $100,000 a year, priced at a 6.5% yield, is worth about $1.5 million. If the market moves to 7.5%, it's worth about $1.33 million. Around $200,000 of value moves with nothing physical changing.

For most private investors, the realistic entry point is about $500,000 to $5 million: small industrial units, strip shops and medical suites.

Six differences from residential

The lease is the asset. A 20 to 50-page lease decides who pays rates, land tax and repairs, how rent rises, and the condition the property comes back in.

The tenant pays the outgoings. Rates, water, building insurance, often land tax, cleaning and fire servicing.

Vacancy is rare but brutal. A commercial property can sit empty for 6 to 12 months or longer, and you pay all the outgoings while it does.

The certain lease term is shorter than advertised. A "5+5+5" lease is 5 years of certain income plus two options that belong to the tenant. Price the 5, treat the rest as upside.

Finance is shorter and tighter. Typically 65 to 70% lending on a 3 to 5-year facility that is revalued and reapproved at expiry. Interest cover is often the real limit, so test at a couple of points above your actual rate.

The tenant's strength is priced in. A lease to a national company with a guarantee is worth more than the same lease to a sole trader.

Commercial property in an SMSF

Business real property is real property used wholly and exclusively in a business. An SMSF can buy it from a related party and lease it back to one, including your own business.

Business owners can pay the same rent to their own super fund instead of a landlord, where income is taxed at 15% in accumulation and potentially nil in pension phase.

It suits super's mechanics for non-business owners too: higher income, long leases and tenant-paid outgoings.

Compliance is everything. Charge full market rent, in writing, paid on time, every time. Non-arm's-length dealings can see income taxed at the top marginal rate.

Borrowing must use a limited recourse borrowing arrangement, borrowed money can't improve the property, and lending is narrower, dearer and lower leverage.

Liquidity matters. The fund must cover repayments, insurance, expenses and pensions without a forced sale.

Five things to look out for

A yield that looks too good. Two points above comparables means a risk sits in the lease, title, planning file or building.

Rent that isn't real. Incentives like rent-free periods or fit-out contributions often sit in a side deed. Ask in writing for every incentive and side agreement, and have them warranted in the contract.

Tenants on a periodic lease. Month-to-month gives no security, and a valuer will treat the property as close to vacant.

Discretionary spending tenants. Groceries, medicine, childcare, fuel and vets hold up in downturns. Fashion, furniture, homewares, jewellery and restaurants get cut first.

Contamination. Any automotive, industrial, fuel or waste history needs an environmental assessment. Remediation can exceed the property's value.

Where the opportunity sits

Industrial is the most forgiving: generic buildings, simple leases, wide tenant pools and scarce, well-located land.

Medical is the most defensive: demand follows demographics, and tenants with expensive fit-outs rarely move.

Daily needs retail anchored by a supermarket, chemist or bakery has proven more durable than expected.

Be cautious on secondary office. The wide yields reflect real risk.

The move this week

Business owners paying rent: ask your accountant whether your super fund could own your premises.

Everyone else: ask an agent for the lease on a listed commercial property and spend 20 minutes reading it.

Key quote

"You're not buying a building, you are buying a contract." — Ben Plohl

Resources

Book a time to chat with Ben or the BFP team: [https://bfpproperty.com/contact]

More from BFP: https://bfpproperty.com/