Commercial Property Asset Classes

Introduction

Commercial property, also known as commercial real estate, is any property that is used for business purposes, such as offices, retail, industrial, hospitality, childcare, medical and service stations. Commercial property can be classified into different asset classes based on the characteristics, location, and performance of the property. The main commercial property asset classes are:

• Office
• Retail
• Industrial
• Hospitality
• Childcare
• Large Format Retail
• Medical
• Service Stations
• Land Development

Office

Office properties are buildings that provide workspaces for businesses, such as corporations, law firms, government agencies, or medical practices. Office properties can be further divided into sub-classes based on the quality, location, and amenities of the building. The most common sub-classes are:

• Premium: These are the highest quality office buildings, usually located in prime locations, with modern design, high-end finishes, and state-of-the-art technology. They attract the most prestigious tenants and command the highest rents.
• A Grade: These are the high-quality office buildings, usually located in central locations, with good design, finishes, and technology. They attract a mix of corporate and professional tenants and have high rents.
• B Grade: These are the medium-quality office buildings, usually located in fringe locations, with average design, finishes, and technology. They attract a variety of tenants and have moderate rents.
• C Grade: These are the low-quality office buildings, usually located in peripheral locations, with outdated design, finishes, and technology. They attract the least desirable tenants and have the lowest rents.

Retail

Retail properties are buildings that provide spaces for businesses that sell goods or services to consumers, such as shops, restaurants, or entertainment venues. Retail properties can be further divided into sub-classes based on the size, configuration, and tenant mix of the building. The most common sub-classes are:

• Regional centre: These are large retail properties, usually with more than 50,000 square metres of gross lettable area, that have multiple anchor tenants, such as department stores, supermarkets, or cinemas, and a variety of smaller tenants, such as specialty stores, food courts, or services. They are usually located in suburban areas and serve a large trade area.
• Neighbourhood centre: These are medium-sized retail properties, usually with 10,000 to 25,000 square metres of gross lettable area, that have one or more anchor tenants, such as supermarkets or discount department stores, and a mix of smaller tenants, such as pharmacies, banks, or cafes. They are usually located in residential areas and serve a local trade area.
• Convenience centre: These are small retail properties, usually with less than 5,000 square metres of gross lettable area, that have no anchor tenants and a few smaller tenants, such as convenience stores, newsagents, or takeaway outlets. They are usually located along major roads and serve a nearby trade area.

Industrial

Industrial properties are buildings that provide spaces for businesses that produce, store, or distribute goods, such as factories, warehouses, or logistics centres. Industrial properties can be further divided into sub-classes based on the use, design, and location of the building. The most common sub-classes are:

• Manufacturing: These are industrial properties that are used for the production of goods, such as automobiles, textiles, or chemicals. They usually have large floor areas, high ceilings, heavy power, and specialised equipment. They are usually located in industrial zones or near transport hubs.
• Warehouse: These are industrial properties that are used for the storage of goods, such as raw materials, finished products, or inventory. They usually have large floor areas, low ceilings, moderate power, and loading docks. They are usually located near major roads or railways.
• Business park: These are industrial properties that are used for a combination of office, showroom, and warehouse functions, such as research and development, light manufacturing, or distribution. They usually have small to medium floor areas, medium ceilings, light power, and drive-in doors. They are usually located in suburban areas or near major roads.

Hospitality

Hospitality properties are buildings that provide accommodation and services for travellers, such as hotels, motels, or resorts or just standalone pubs, taverns, and entertainment venues. Hospitality properties can be further divided into sub-classes based on the quality, amenities, and market segment of the property. The most common sub-classes are:

• Luxury: These are the highest quality hospitality properties, usually with five-star ratings, that offer the most luxurious rooms, facilities, and services, such as spas, concierge, or fine dining. They attract the most affluent and discerning guests and charge the highest rates.
• Upscale: These are the high-quality hospitality properties, usually with four-star ratings, that offer comfortable rooms, facilities, and services, such as fitness centres, business centres, or room service. They attract a mix of business and leisure guests and charge high rates.
• Midscale: These are the medium-quality hospitality properties, usually with three-star ratings, that offer basic rooms, facilities, and services, such as breakfast, Wi-Fi, or laundry. They attract mostly budget-conscious guests and charge moderate rates.
• Economy: These are the lowest quality hospitality properties, usually with one or two-star ratings, that offer minimal rooms, facilities, and services, such as beds, bathrooms, or vending machines. They attract mostly price-sensitive guests and charge the lowest rates.
• Pubs/Taverns/Entertainment Venues: These are the hospitality properties that offer food and drinks, usually with a focus on alcoholic beverages, such as beer, wine, or spirits. They may also have entertainment options, such as live music, karaoke, or sports. They attract mostly casual and social guests and charge low to moderate rates. They may or may not have rooms for accommodation. They are typically rated by the quality of their food, drinks, service, and atmosphere.

Childcare

• Childcare centres are classified as social infrastructure, which is a sub-sector of alternative real estate that includes assets such as schools, hospitals, aged care, and student accommodation.
• Childcare centres are valued based on their net operating income (NOI), which is the difference between the gross income and the operating expenses. The NOI is influenced by factors such as the location, quality, size, occupancy, and fee structure of the centre, as well as the demand and supply of childcare services in the area.
• Childcare centres are typically leased to operators on a net basis, which means that the tenant is responsible for paying all the property taxes, building insurance, and maintenance costs. The lease terms are usually long, ranging from 10 to 25 years, with fixed or CPI-linked rent reviews and options to renew.
• Childcare centres are considered as defensive assets, as they have low correlation with the economic cycle and high demand from both parents and government. The demand for childcare services is driven by factors such as population growth, female labour force participation, household income, and government policies and subsidies. The supply of childcare services is constrained by factors such as land availability, planning regulations, and licensing requirements.

Large Format Retail

Large Format Retail properties are buildings that provide spaces for businesses that sell large or heavy items, such as furniture, appliances, or hardware. Large Format Retail properties can be further divided into sub-classes based on the size, layout, and location of the building. The most common sub-classes are:

• Large Format Retail Centres: These are Large Format Retail properties that have large floor areas, usually over 5,000 square metres, and offer a wide range of products, such as home improvement, electronics, or sporting goods. They usually have open-plan layouts, high ceilings, and ample parking. They are usually located in highway or regional areas and have higher rents.
• Showroom: These are Large Format Retail properties that have medium floor areas, usually between 1,000 and 5,000 square metres, and offer a limited range of products, such as furniture, flooring, or lighting. They usually have partitioned layouts, medium ceilings, and moderate parking. They are usually located in arterial or suburban areas.
• Trade centre: These are Large Format Retail properties that have small floor areas, usually under 1,000 square metres, and offer a specialised range of products, such as plumbing, electrical, or automotive. They usually have closed layouts, and less parking requirement. They are usually located in industrial or urban areas.

Medical

Medical properties are buildings that provide spaces for businesses that offer health care services, such as clinics, hospitals, or laboratories. Medical properties can be further divided into sub-classes based on the type, scale, and location of the facility. The most common sub-classes are:

• Primary care: These are medical properties that offer general or routine health care services, such as GPs, dentists, or optometrists. They usually have small to medium floor areas, low to moderate staff and equipment, and simple design and layout. They are usually located in neighbourhood or community areas and have moderate rents.
• Specialty care: These are medical properties that offer specific or specialised health care services, such as cardiologists, dermatologists, or radiologists. They usually have medium to large floor areas, moderate to high staff and equipment, and complex design and layout. They are usually located in regional or urban areas and have moderate to high rents.
• Acute care: These are medical properties that offer intensive or emergency health care services, such as hospitals, trauma centres, or surgery centres. They usually have large to very large floor areas, high to very high staff and equipment, and sophisticated design and layout. They are usually located in central or strategic areas and have high to very high rents.

Service Stations

Service stations are buildings that provide spaces for businesses that offer fuel and convenience products, such as petrol, diesel, or snacks. They are a type of commercial property that can offer investors attractive returns, stable income, and long-term leases. Service stations can be further divided into sub-classes based on the size, configuration, and location of the facility. The most common sub-classes are:

• Freeway: These are service stations that are located along major highways or freeways, and offer fuel and convenience products, as well as other services, such as restaurants, restrooms, or car washes. They usually have large sites, multiple pumps, and large convenience stores. They have high traffic volumes and high rents.
• Metro: These are service stations that are located in urban or suburban areas, and offer fuel and convenience products, as well as some services, such as ATM, lottery, or coffee. They usually have medium sites, single or double pumps, and medium convenience stores. They have moderate traffic volumes and moderate rents.
• Rural: These are service stations that are located in rural or remote areas, and offer fuel and convenience products, as well as limited services, such as ice, propane, or bait. They usually have small sites, single pumps, and small convenience stores. They have low traffic volumes and lower rents.

Characteristics of Service Stations

Service stations are typically located on strategic sites with high exposure, traffic flow, and accessibility. They often have large land parcels that can accommodate future expansion or redevelopment. Service stations are usually leased to major fuel retailers or operators, such as BP, Shell, Caltex, or 7-Eleven, who pay rent to the property owner. The leases are usually long-term, ranging from 10 to 20 years, with options to renew. The rent is often subject to annual or periodic increases, based on fixed rates, CPI, or market reviews. The leases are also usually structured as net leases, meaning that the tenant is responsible for all outgoings, such as rates, taxes, insurance, and maintenance.

Performance of Service Stations

Service stations have performed well as a commercial investment asset class in Australia, especially in the context of the COVID-19 pandemic. According to CBRE, the total sales volume of service stations in 2020 was $1.14 billion, up 23% from 2019. The average yield for service stations in 2020 was 5.37%, down 44 basis points from 2019, indicating strong capital growth. The demand for service stations was driven by their defensive nature, resilient income, and essential service status. Service stations also benefited from the shift in consumer preferences towards private car use and domestic travel, as well as the growth in convenience retailing and online delivery.

Land Development

Land development properties are parcels of land that are used for the construction or improvement of buildings, infrastructure, or amenities, such as residential, commercial, or mixed-use projects. Land development properties can be further divided into sub-classes based on the stage, size, and location of the development. The most common sub-classes are:

• Raw land: These are land development properties that have no improvements or entitlements, and require extensive planning, zoning, and permitting before construction can begin. They usually have large sites, low density, and low accessibility. They have higher risk and values can vary significantly.
• Entitled land: These are land development properties that have some improvements or entitlements, and require moderate planning, zoning, and permitting before construction can begin. They usually have medium sites, medium density, and medium accessibility. They have moderate risk and moderate value.

Quick Guide – Yield Range by Investment Class

Asset Class	Indicative Yield Range
Office	5.5% - 7.5%
Retail	4.5% - 7.0%
Industrial	4.5% - 6.5%
Hospitality	6.0% - 8.0%
Childcare	5.5% - 7.0%
Large Format Retail	5.2% - 6.7%
Medical	4.5% - 7.0%
Service Stations	5.5% - 7.5%

*These are just indicative ranges and vary depending on various factors. It is always advisable to consult with a professional before making any investment decisions.

A Brief Summary on Commercial Property

Net Income, Semi Gross Income, Gross Income and Yield Return

What is Commercial Property?

Commercial property is any real estate that is used for business purposes, such as offices, retail stores, warehouses, hotels, industrial buildings, service stations, childcare and medical. Commercial property can generate income for the owner through rent, capital appreciation, or typically both.

What are the Different Types of Income from Commercial Property?

There are three main types of income from commercial property: net income, semi gross income, and gross income. Each type of income reflects a different level of expenses that are deducted from the total revenue generated by the property.

• Net income is the income that remains after deducting all operating expenses, such as property taxes, insurance, maintenance, utilities, and management fees, from the total revenue. Net income is also known as net operating income (NOI).
• Semi gross income is the income that remains after deducting some, but not all, operating expenses from the total revenue. Semi gross income is also known as net rent or effective gross income (EGI). The expenses that are deducted from semi gross income may vary depending on the lease agreement, but typically include property taxes and insurance.
• Gross incomeis the income that remains before deducting any operating expenses from the total revenue. Gross income is also known as gross rent or potential gross income (PGI). Gross income represents the maximum income that the property can generate.

What is Yield Return from Commercial Property?

Yield return is the ratio of the annual net income to the purchase price or market value of the property. Yield return is also known as capitalization rate or cap rate. Yield return measures the profitability of the property and the return on investment for the owner. A higher yield return indicates a higher income relative to the property value, and vice versa.

Yield return can be calculated by dividing the annual net income by the purchase price or market value of the property. For example, if a property generates $100,000 of net income per year and is valued at $1,600,000, the yield return is 6.25% ($100,000 / $1,600,000).

Why Should You Invest in Commercial Property?

Investing in commercial property can offer several benefits for investors, such as:

• Diversifying your portfolio and reducing your risk exposure to other asset classes, such as stocks and bonds.
• Generating a steady and predictable income stream from rent payments, which can help you cover your expenses and achieve your financial goals.
• Benefiting from capital appreciation, which is the increase in the value of the property over time, due to factors such as market demand, location, quality, fixed rental increases and improvements.
• Enjoying tax advantages, such as depreciation, which allows you to deduct a portion of the cost of the property from your taxable income, and capital gains tax exemptions, which allow you to pay lower taxes on the profit from selling the property.
• Leveraging your investment, which means using borrowed funds to purchase the property, and increasing your potential returns by paying lower interest rates than the yield return of the property.

However, investing in commercial property also involves some challenges and risks, such as:

• Requiring a larger amount of capital upfront, which can limit your liquidity and flexibility.
• Facing higher maintenance and operating costs than residential property, which can reduce your net income and cash flow.
• Dealing with complex and variable lease agreements, which can affect your income stability and legal obligations.
• Experiencing market fluctuations, which can affect the demand, occupancy, and value of the property

Therefore, before investing in commercial property, you should do your research, analysis, and due diligence, and consult with a professional advisor, to ensure that you make an informed and profitable decision.