Investing in Commercial Property

 

Investing in commercial property can be a rewarding strategy for building wealth, but it comes with distinct considerations compared to the familiar world of residential real estate. Commercial properties – offices, shops, warehouses, etc. – offer higher income potential but also involve longer leases, unique tax and lending rules, and greater complexity in management. This guide will explain what commercial property is, how it differs from residential property, and key concepts (from yields to self-managed super fund strategies) to help business owners and investors make informed decisions.

What is Commercial Property?

Commercial property refers to real estate used for business activities rather than personal living. In simple terms, it’s property “where business is conducted” – for example, office buildings, retail shops, medical consulting rooms, warehouses, and factories. These are the places companies operate and customers shop or receive services. Commercial property can be owned by an investor-landlord (who leases it out) or by an owner-occupier (a business that owns its premises). By contrast, residential property is used for living (homes, units, apartments) and is governed by different rules.

Commercial vs. Residential: Key Differences

Many investors are more familiar with residential property, so it’s useful to compare how commercial property investment differs across several dimensions. Broadly, commercial real estate offers higher returns but with higher risk and more stringent requirements, whereas residential real estate provides stability and easier entry. The table below summarises the key differences:

Aspect	Residential Property	Commercial Property
Lease Terms & Tenants	Short leases (typically 6–12 months) with strong legal protections for tenants. Standardised agreements under consumer tenancy laws; easier for tenants to exit or be evicted if needed.	Long leases (commonly 3–5 years, often with multi-year renewal options) negotiated case-by-case. Fewer statutory protections – terms are contractually agreed and often drafted by lawyers. Tenants seek security of tenure due to high relocation costs.
Outgoings & Maintenance	Landlord pays most outgoings (council rates, building insurance, maintenance, etc.) and handles upkeep in order to attract and retain tenants. These expenses reduce the net income for the owner.	Tenants usually pay a significant portion of outgoings per lease terms. Commonly a net lease where tenant covers council rates, insurance, repairs, and sometimes even land tax for larger properties. This shifts costs off the landlord, leading to better net cash flow.
Vacancy Risk	Generally lower vacancy risk – there’s broad demand for housing, so empty periods tend to be shorter (depending on location and price). Losing a tenant is a concern, but re-leasing a home is often faster.	Higher vacancy risk – finding a new business tenant can take time. Commercial demand is tied to the economy; an office or shop might sit vacant for months if the market is weak. (For example, after COVID-19 many offices struggled to find tenants.) Owners may need substantial cash reserves to cover mortgage and costs during vacancies.
Rental Yields	Typical gross rental yield  approximately 3 to 4% per annum in Australia. Net yields are lower after expenses. Residential investors often rely on long-term capital growth, with rental income covering only part of costs.	Higher rental yields, often in the 5–10% range gross (varying by property type and location). Even after expenses, net yields tend to beat residential. The higher income reflects the higher risk; it can also mean positive cash flow, especially since many running costs are borne by the tenant.
Tax Treatment (GST & Depreciation)	No GST applies to residential rent or standard home sales. Owners can deduct expenses and loan interest; building depreciation is claimable on newer structures (or renovations) but may be limited on older properties. Capital gains tax (CGT) is payable on sale profits (with a 50% discount for individuals after 1 year).	GST applies to most commercial property transactions: landlords register for GST to charge 10% on rent and outgoings (must lodge BAS returns) and commercial sales usually attract GST unless an exemption applies. All operating costs (repairs, interest, etc.) are tax-deductible against rental income. Depreciation on the building and fit-outs can be significant, so getting a depreciation schedule is important. CGT applies on sale gains similarly (with 50% discount for individuals/trusts after 1 year).
Financing	Easier to finance: banks typically lend up to 80% of a home’s value (even 90–95% with lenders’ mortgage insurance). Loan terms approximately 25 to 30 years at standard home loan interest rates. Approval depends on borrower’s income and credit, and the property’s value.	Harder to finance: banks often require a 30–35% deposit (max 65 to 70% LVR) for commercial loans. Loan terms are shorter (e.g. 10–15 year amortisation) and interest rates are higher due to perceived risk. Lenders closely assess the property’s lease quality and tenant financial strength, sometimes needing specialised valuations.

Key Commercial Property Terms Explained

Stepping into commercial real estate introduces some new jargon. Here are four essential terms you’ll encounter:

• Yield: In property, yield refers to the annual rental return as a percentage of the property’s value. It’s calculated as yearly rent divided by the purchase price (or current value) of the property. For example, a property earning $80,000 rent and valued at $1 million has an 8% yield. Investors distinguish gross yield (before expenses) from net yield (after expenses) when evaluating income. Yield is a critical metric for commercial property – values often move inversely with yields (high-demand properties have lower yields, and vice versa).
• Gross Lettable Area (GLA): This term means the total floor area available to be rented out in a commercial building. GLA is usually measured in square meters and includes all space within the external walls that a tenant can occupy. Rent prices for offices or warehouses are commonly quoted “per square metre”, so knowing the GLA is essential for comparing properties. (For instance, a warehouse might be advertised at $200 per m²; if its GLA is 500 m², the annual rent would be $100,000.)
• Covenant (Property Covenant): A covenant in real estate is a condition on the title that restricts how the property can be used. Commercial properties may come with covenants or zoning restrictions that limit certain activities. For example, a covenant might forbid a property from being used as a bar or hotel if it’s near a school. When purchasing, it’s important to review any covenants, as they could affect your intended use or the type of tenants you can attract.
• CPI (Consumer Price Index) Adjustments: Leases often include rent review clauses. CPI is the Consumer Price Index – basically the inflation rate as measured by the Australian Bureau of Statistics. A CPI rent review means the rent will increase each year in line with inflation. For instance, if CPI is 3% in a given year, the rent will rise 3%. Some commercial leases use fixed percentage increases (e.g. +3% per year) or a combination of CPI and fixed adjustments. These mechanisms protect the landlord’s income from inflation over long lease terms.

Tax Implications of Commercial Property

From a tax perspective, commercial property has a few important differences (and opportunities) compared to residential:

• GST (Goods and Services Tax): Perhaps the biggest difference is that renting or selling commercial property is subject to GST, whereas residential rent is GST-free. If you own a commercial building and the rent (plus other business income) exceeds the GST threshold ($75,000 per year), you must register for GST. You’ll need to add 10% GST to the rent you charge tenants and remit it to the ATO via regular Business Activity Statements (BAS). The good news is you can typically claim GST credits on your property expenses (repairs, management fees, etc.), which offsets the GST you pay out. This GST obligation is a crucial compliance step for commercial landlords – many first-time investors seek advice from their accountant to ensure they handle registrations and BAS filings correctly.
• Income Tax and Deductions: For income tax, rental income from commercial property is added to your taxable income just like residential rent would be. Similarly, owners can deduct all expenses related to earning that income – including interest on loans, council rates, insurance, maintenance, property management fees, and more. One often significant deduction is depreciation. Commercial buildings (and eligible fit-out or plant & equipment assets) depreciate over time, and those depreciation amounts can be written off against income. Investors should obtain a professional depreciation schedule to maximise these deductions; it’s common to find sizable tax write-offs each year, especially for newer buildings or recently renovated premises. (It’s worth noting that residential property also allows building depreciation in many cases, but recent tax law changes have restricted certain depreciation claims on second-hand residential properties. Commercial properties don’t have those same restrictions, making depreciation a notable benefit.)
• Capital Gains Tax (CGT): When you eventually sell the property, any profit (capital gain) will generally be subject to CGT, whether it’s commercial or residential. The rules for calculating capital gains are largely the same for both types – for instance, individuals or trusts get a 50% CGT discount if the property was held for more than 12 months, which effectively halves the taxable gain. One thing to watch in commercial deals is GST on sales: selling a commercial property will usually attract GST on the sale price (which the seller must account for), unless the sale qualifies as a GST-free going concern or another exemption. This is a complex area, but basically if you sell a tenanted commercial property and meet certain conditions, the transaction can be structured as GST-free. It’s advisable to get tax advice ahead of a commercial property sale because the GST and CGT outcomes can significantly impact your net proceeds.

Financing and Lending Considerations

Financing a commercial property purchase is quite different from getting a home loan. Lenders view commercial real estate as higher risk, so they impose more stringent terms:

• Loan-to-Value Ratio (LVR): For residential homes, banks commonly lend 80% of the property’s value (and sometimes up to 90-95% with mortgage insurance). In commercial lending, the typical maximum LVR is much lower. Banks will often only lend around 60–70% of the property value for a commercial investment. In other words, you need a 30-40% deposit (plus enough to cover purchase costs like stamp duty). This higher equity requirement can be a barrier to entry for many investors. It also means the borrower has more “skin in the game,” which lenders feel is necessary given the volatility in commercial occupancy.
• Interest Rates and Terms: Commercial property loans usually carry higher interest rates than standard home loans. The difference might be on the order of 1% or more in interest – for example, if home loans are 5%, a commercial loan might be 6–7%, depending on the deal. Additionally, loan terms are shorter. Instead of a 30-year mortgage, commercial loans might amortise over 15 or 20 years, or sometimes be structured with a shorter review period (e.g. a 5-year term with a balloon payment or refinancing at that point). Shorter terms and higher rates mean higher monthly repayments, so investors must ensure the property’s cash flow can support the debt. It’s common to see commercial loans structured on an interest-only basis for a few years (to improve cash flow), with principal payments coming later, but this varies by lender.
• Loan Approval Factors: When assessing a commercial property loan, lenders focus heavily on the property’s characteristics and the lease income. Key factors include:
  • Quality of the Tenant: Is the tenant a well-established business or a risky start-up? A blue-chip corporate or government tenant makes a lender more comfortable than a vacant property or a struggling business tenant.
  • Lease Terms: A long lease in place (especially with options) provides secure income, which banks like. If the property is vacant or the lease is short-term remaining, the bank may lend a smaller amount or even decline the loan until a lease is secured.
  • Cash Flow Coverage: Lenders will look at the rent and ensure it comfortably covers the loan payments. They often require that net rent exceeds the loan’s interest expenses by a certain margin (a debt coverage ratio).
  • Property Condition and Use: Specialised properties (e.g. a single-purpose factory or a remote hotel) might be considered higher risk than a generic office or a suburban shop, affecting the terms. The bank will usually require a professional valuation of the property, and sometimes building inspections or environmental reports, before approving the loan.
• Personal/Additional Security: Unlike most home loans, commercial loans may require additional guarantees or security. For small business owners, banks often ask for personal guarantees or even collateral like residential property equity to secure a commercial loan. They want assurance they’ll be repaid even if the business tenant fails.

Due Diligence When Buying Commercial Property

When purchasing a commercial property, thorough due diligence is absolutely vital. There are more things that can “go wrong” or require investigation in a commercial deal compared to a simple house purchase. Here are key due diligence steps and why they matter:

• Title and Zoning Checks: Always review the title documents for any encumbrances or covenants (as mentioned earlier) that restrict use. Equally important, confirm the zoning and permitted use of the property with the local council. Never assume that a current use is allowed – the property might have existing use rights or even be operating outside proper zoning. For example, a medical clinic in a building zoned residential (as in a real case in South Australia) can trigger council action to cease operations. In that case, the buyer had to scramble to make costly building upgrades to meet commercial codes.
• Existing Lease Review: If the property is being sold with existing tenants and leases, read those lease agreements meticulously. You will inherit those leases as the new owner. Check the rent amount, lease term and expiry dates, options to renew, rent review schedules (e.g. upcoming CPI increases), and any unusual provisions. Pay attention to clauses about outgoings (who pays for what), maintenance responsibilities, and make-good obligations at lease end. For instance, if a tenant only has 6 months left on their lease, you face an imminent vacancy unless they renew – that affects the valuation and your risk. If the lease has several years to run but at an abovemarket rent, consider whether the tenant might seek a reduction or leave when possible. Conversely, a below-market rent could be an opportunity to increase income later. Understanding the leases is crucial to valuing the property and planning your cash flow.
• Building Inspection and Condition: Just as you’d inspect a house, get a building and pest inspection for a commercial property. Older commercial buildings might have issues with asbestos, roofing, or compliance with modern building codes. Ensure that the structure is sound and note any repairs or capital works you might need to undertake. The inspection should also cover compliance items like fire safety systems, electrical wiring, and access (e.g., disability access requirements for public buildings). If the property has specialised equipment (like lifts, HVAC, or industrial fittings), consider engaging specialists to assess those. Repair costs can be much higher for commercial structures, so know what you’re buying into.
• Environmental and Site Checks: For certain properties (especially industrial sites, warehouses, or older service stations), there could be environmental contamination risks. It might be worth doing environmental searches or soil tests to ensure there are no hazardous materials or legacy issues (like underground fuel tanks or chemical contamination) that could impose liability or cleanup costs on you as the new owner. Similarly, check for any heritage listings or easements on the property that might limit modifications.
• Legal Due Diligence: Engage a commercial solicitor or conveyancer experienced in commercial property to help with the contract and due diligence. They will check title, zoning, and review lease documents, and can negotiate contract terms to protect you (such as making the purchase conditional on finance approval or satisfactory due diligence). Often, a sale contract for commercial property can be amended to include warranties from the seller – for example, that all plant and equipment is in working order, or that the current use is lawful. Your legal advisor will know what to ask. This expertise is worth the investment given the complexity of commercial deals.

Using an SMSF to Buy Commercial Property (Business Premises)

One popular strategy, especially for small business owners and professionals, is to purchase commercial property through a Self-Managed Superannuation Fund (SMSF). In fact, many businesses have used their SMSFs to buy their own premises – it can be a very tax-effective long-term investment. Here’s how it works and what to consider:

The Business Real Property Exception: Normally, superannuation funds are quite restricted in what they can invest in – for example, they generally cannot buy assets from a related party (like purchasing a property you already own) nor lease assets to related parties. However, there is a crucial exception for “business real property.” Australian super laws allow an SMSF to acquire a commercial property (business real property) from a member or related entity and lease it to a related party (like the member’s own business), as long as it’s all done on market terms. In plain English, your SMSF can buy your business premises and then rent it to your business, legally. This strategy turns your rent payments into retirement savings: instead of paying rent to an outside landlord, you pay rent to your own super fund (which will eventually fund your retirement).

Benefits of the SMSF route:

• Tax Advantages: Income in a super fund is taxed at only 15%. Capital gains in super are taxed at 10% if the asset was held for over a year (and 0% in retirement/pension phase). Compare this to owning the property personally or in a company – rents could be taxed up to 47% at the top marginal rate, and capital gains at 23.5% (for individuals after discount) or 30% for companies, depending on the situation. The SMSF essentially provides a low-tax environment for the property investment. Over many years, the tax savings and compounded growth can be substantial.
• Retirement Savings Boost: Using your business rent to pay off a property in your SMSF means by the time you retire, you could fully own your premises within super. At that point, if the property is sold while the SMSF is in pension mode, there may be no capital gains tax at all on the sale (since retirement phase super funds pay 0% tax on income or gains).
• Control and Security: As a business owner, owning your premises (even if indirectly through your super fund) gives you more control. You won’t have to worry about the landlord selling the property or drastically increasing rent. So long as your SMSF abides by market terms, you effectively set your lease conditions with yourself – often a very stable arrangement. It can also protect the property from business risks; if something happens to your business, the property is still an asset of your super fund, separate from the business’s finances.

Compliance and Advice: Using an SMSF for property requires careful compliance with superannuation laws. The property must always be rented on market terms (you can’t short-change your super fund or overpay rent artificially). All transactions must be documented properly, and you must pass the sole purpose test – the investment must be solely to provide retirement benefits, not to give current-day benefits to members (aside from being a legitimate tenant). Most of the time, if structured correctly, owning your business’s premises in your SMSF is acceptable and common. But one should engage qualified advisers to set it up right. There are also costs to consider: e.g. the SMSF will have to pay stamp duty on purchase and any loan setup costs, just like any buyer, and there will be ongoing administration for the fund.

Conclusion

Commercial property can be an excellent addition to an investment portfolio or a smart way to secure your business premises, provided you understand the differences and manage the risks. Compared to residential property, it offers higher rental returns, longer leases, and unique tax benefits, but demands greater due diligence, larger upfront investment, and active management. By being aware of tenancy dynamics, mastering key concepts like yield and lease structures, and leveraging strategies (like SMSFs for business owners), investors can confidently approach commercial real estate opportunities.

If you’re considering investing in commercial property – whether directly or through your super fund – take the time to educate yourself and seek professional advice. With careful planning and the right support, commercial property investment can become a powerful vehicle for wealth creation and business stability.

 

This general advice has been prepared without taking account of your objectives, financial situation or needs. You should consider the appropriateness of this advice before acting on it. If this general advice relates to acquiring a financial product, you should obtain a Product disclosure Statement before deciding to acquire the product.