March 27, 2018 - Peak Equities

Understanding the Different Classes of Commercial Real Estate

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Commercial Real Estate is an attractive asset class for investment, offering strong returns and capital growth. Each segment within this class has its own particular characteristics and complexities. The first step in navigating these unique challenges is to be aware of the salient details of each major segment within the class.

  • Office

Office buildings, small or large, can be ideal investment-grade assets, but a sound understanding is critical to making an informed investment decision. Office buildings can be found in CBDs, CBD fringes, urban or regional areas each with differing market conditions, trends, demand levels, tenant expectations etc.  Assets of this kind can be sold as freehold, leasehold, strata titled or unencumbered, each of which will significantly affect the market value, management requirement and future saleability.

Competition to find or retain tenants in the sector can be fierce. Accordingly, an investor must understand trends including; per square meter market rentals, standard incentives, net absorption rates and more. Usually with multiple tenants to manage and a high standard of maintenance required, investors must also have a good working knowledge of a property’s mechanical systems, including but not limited to lifts, air conditioning, electrical and fire safety. Finally, understanding the tenant’s business, who the decision maker is, whether it is a head or satellite office, ASX listed company or smaller operation will have implications for end of lease negotiations and the prospects of retention.

Professional investment companies offering participation to Sophisticated Investors such as Peak Equities are renowned for their assessment of assets of this kind.

  • Industrial

Industrial assets can offer strong returns, strategic land holding and relatively low management inputs. The counter to these attributes is that their value can be volatile and particularly sensitive to tenant movements and the length of leases. Different industrial asset types include warehouses, logistics facilities, cold storage, manufacturing centres and more and the implications of owning and managing each kind can be very different. The specific zoning and permitted use of an industrial asset will limit the kind of tenants that can be accommodated, while the activity that a tenant intends to conduct on site will affect the risk and insurability of the asset. The span and height of a warehouse as well as its accessibility for large vehicles will also materially affect an asset’s ability to attract or retain tenants, rent levels that can be achieved and future development prospects.

While many investors consider industrial assets attractive owing to the fact that tenants frequently commit to long term leases, vacancies can take months or even years to fill and require considerable incentive payments, and if repairs or remediation works (particularly with regard to asbestos or soil contamination) are required, they can involve considerable expense, particularly with large or ageing assets.

  • Retail

Retail assets vary greatly in their nature, size, location and the type of use. Size and location can broadly be broken down into bulky goods, shopping strip, shopping centre or stand-alone shop, while business operation can include everything from services, food, fashion, entertainment or lifestyle, each with different preferences, priorities and needs. Retail investments can offer diversified tenant risk and lease expiry profiles, the corollary to which will often result in more involved management requirements.

When considering or owning a retail asset, familiarity with the Retail Leases Act in the asset’s particular state or territory is required as retail leases impose obligations on landlords which office or industrial leases do not. As with other asset categories, knowledge of current market conditions, market lease rates, incentives and vacancy rates are also critical to maximising the value of an investment. The mix of tenants in a strip or shopping centre is critical to the sustainability of tenant businesses, too many similar or non-complimentary tenants can be an obstacle to the viability of a tenant’s business and ability to pay rent. In some cases, offering tenants exclusivity over a particular product category or service offering can be a useful approach.

Finally, an anchor tenant (such as a Coles or Woolworths) on a long lease can be particularly valuable in a shopping strip or centre to drive traffic to the centre, extend the lease expiry profile and add considerable value overall.

At its core, successful commercial real estate investing requires learning everything that can be learned about an asset; analysing and understanding the prevailing market conditions; risk factors and management requirements; and understanding the path to preserve and enhance value. Real Estate Investment Trusts (REITs) are entities which own income producing real estate and which are often managed by professional trustees or licensed real estate investment managers. Organisations of this type can be invaluable in lowering the risk and management burden while also adding value for investors/unit holders.

For a confidential discussion about commercial real estate investment opportunities, speak to the team at Peak Equities directly by calling (03) 9863 8380 or email and always seek independent investment advice from a licensed professional before making any decisions.

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