Commercial Property Investment for Beginners

Why should I make a commercial property investment?

Commercial property, when combined with other investments, can offer important diversification to your investment portfolio, including the prospect of income (rent payments) and growth (prospective land and building value gains). Diversification helps to lower your overall risk and helps in achieving more stable returns.

If you are interested in introducing commercial property to your portfolio it is worth assessing its long-term performance relative to other asset classes, noting historical data provides no assurance of future performance.

Diversification is a great strategy to guard against a single investment’s volatility or one asset class performing poorly (e.g., a fund manager failing or a collapse in the share market).

With market movements happening all the time, diversification can help to flatten out the overall performance of your portfolio i.e., when some decrease in value, others may increase and balance out the fall. Overall, diversification lowers the risk to your portfolio performance as no matter what happens in the economy, some investments are likely to benefit.

Commercial property investment is underpinned by the tenants who pay rent to the owners of the building – in Centuria’s case, that would be the fund. The profit on the rent is then distributed to the owners of the fund in the form of distributions.

What this means is that the relationship with and quality of the tenants are paramount. In Centuria’s case, we believe this to be a real point of difference in our acquisition strategy and our preference to actively manage our buildings.

We recommend talking to your financial adviser to evaluate your risk profile and whether a commercial property investment would be right for your investment strategy. You should also read the offer document for more information on investment considerations and risks relevant to the financial product.

If you are interested in investing in a property fund, we would also encourage you to check whether the manager is regulated or not, this is often very important. Centuria is licensed and regulated by the Financial Markets Authority.

Types of Commercial Real Estate

Commercial property can be broadly defined as a property which has a direct commercial use. We can categorise commercial property into four broad groups:

Retail

Retail properties are spaces that are used to sell or market consumer goods and services. They include single shops through to large shopping centres or malls.

Office

Office property is space that is used for business purposes and includes large multi-storey office towers through to smaller suburban spaces. Office real estate will include additional facilities for the tenants including end of trip facilities, kitchens, meeting rooms, toilets and desk spaces.

Industrial

Industrial spaces can be extremely large warehouses that are utilised for manufacturing, storage and logistics purposes. On the other end of the spectrum, industrial properties can be smaller and sometimes have a mixture of warehouse and office space. Tenants typically range from logistics distributors to those producing goods.

Healthcare

Healthcare property generally includes real estate that contains healthcare facilities including hospitals,
day hospitals and medical centres. The healthcare sector is underpinned by growing non-discretionary demand for healthcare services.

What makes a good commercial property investment?

Some factors to consider when investing in listed and unlisted property funds include, but are not limited to:

1. stock market volatility, the ability to exit the investment (liquidity),
2. the gearing (level of borrowings) of the properties in the fund and the costs of servicing that debt (interest costs); and
3. understanding the individual characteristics of the properties held by the fund
   1. tenant demand and tenant profile
   2. property valuation metrics
   3. cash flow sustainability
   4. nature of lease agreements
   5. weighted average lease expiry dates
   6. yield – how much rent is being produced
   7. age and state of the building(s), outgoings and location

If you are looking to invest in a commercial property through a fund manager, then you need to assure yourself that they have the experience appropriate for optimising your investment. Before investing, here are some important questions to ask about a fund manager:

• How have they performed historically as a manager?*
• What does their current investment portfolio look like (what are their core investment competencies)?
• Does the manager outsource the management of the property portfolio, or do they internally manage it (do they have direct access to the tenants and properties)?
• Do they have in place a framework for strong management of the asset going forward? This may include having in-house asset managers to maintain the property to the highest standard, so the value is also maintained, but also facilities managers across the property so that tenant sentiment is a priority.

Over 20 years of experience has given Centuria an understanding of the commercial property market cycle, the geographical levers, and demand for the particular types of commercial real estate. This helps with the acquisition and sale of commercial properties in our portfolio.

* Past performance is not a reliable indicator of future performance

The Pros and Cons of Commercial Property Investment

As with any investment, there are always benefits and risks that you should weigh up before making any commercial property investment decisions. A financial adviser can always help in working through what these are and how they may suit your risk profile. In short, these are some general pros and cons of commercial property investment.

Benefits of commercial property investment

Potentially strong returns: combination of the potential for capital gain and income

Income stability: commercial properties that have longer leases lock in tenants for longer periods

Tax benefits: depreciation deductions are available for commercial buildings (but not for residential buildings)

Diversification: Commercial property can assist with diversifying investments across different asset classes. In addition, there are lots of different types of properties to diversify into

Capital gains: commercial property investment has the potential for capital gains if the property value increases

Longer lease terms: usually leases are between 3-15 years as opposed to six months for residential property. This provides longer income certainty than shorter lease terms.

Reduced overhead costs: unlike a residential tenant, the commercial property tenants sometimes pay for all the repairs, maintenance, property management fees and rates in the building.

Net distribution returns: that will often compare favourably to residential property investments (after factoring in gearing).

Potential to add value: as with residential property, it is possible to improve the value of a commercial property investment, however, it will require planning and incur costs.

Risks of commercial property investment

Financial performance of tenants: investment income is derived from rent paid by the tenant, placing importance on the financial performance of tenants.

Stock Market Volatility: if you are investing in commercial real estate via a listed entity on the NZX/ASX, the fund can be influenced by market sentiment as well as the underlying value of the assets.

Valuation risk: commercial property investment has the potential for capital losses if the property value decreases

Liquidity of the property fund – different types of investment have different liquidity levels:

• a closed-ended unlisted property fund will generally have no liquidity until the investors approve the sale of the underlying property
• an open-ended unlisted property fund can offer continuous investment opportunities along with redemptions within specified limits
• a direct property investment allows an investor to sell when the time suits them, assuming there is a market for the property.
• a listed property fund will have increased liquidity as ownership interests can be bought and sold on the exchange  it is listed on.
• Fund values can also be impacted by a fall in fund revenue, unexpected capital expenditure, force majeure and changes in interest rates.

*Centuria, unlike other fund managers in the market offer their investors the benefit of a secondary sales market, whereby if investors wish to sell their interests, the sale is facilitated by Centuria first notifying the scheme of the available interests and, if necessary, the full database of investors. Centuria will provide background information to the investor wishing to sell, in order for them to price their interest. For more information about this, please contact Kerri Ewart, Secondary Sales Manager – kerri.ewart@centuria.co.nz

COVID-19 risks: Any failure of a tenant to pay rent, rent abatements or a reduction in demand will impact the Fund’s revenue. A downturn in the property or share market will have an adverse impact on the value of the fund and return to investors. Existing risks may also be affected or heightened.

Other things to consider

Gearing of the property: commercial investments typically have associated borrowings from a bank, which enables access to higher value assets, and potentially higher value returns. The gearing level, which reflects how much debt is being borrowed, is important. Gearing can magnify gains or losses. Centuria’s gearing of its property assets is typically between 35%-45% of the initial value of the property, which is relatively conservative.

Common terms used in commercial property investment

Gearing – a measure of how much an investment is funded using debt versus the equity provided by investors. Also known as Leverage or LVR.

IM (or Information Memorandum) – an offer document produced for the sale of a product or asset to wholesale investors.

Leverage – the ratio of a company’s loan capital (debt) to the value of its equity. Also known as Gearing or LVR.

Liquidity – refers to how easy it is to convert assets into cash.

Listed property trust/fund – a unitised portfolio of property assets, listed on the New Zealand Stock Exchange (NZX).

LVR (or Loan to Value ratio) – the amount borrowed to purchase an asset (e.g., building/property), represented as a percentage of the value of the asset. Also known as Gearing or Leverage.

PDS (or Product Disclosure Statement) – a legal offer document for a financial product.

Property syndicates – property syndicates are a pooled property investment usually facilitated by a fund manager. Many investors are able to pool their money to buy a property that alone they would not have the funds to purchase.

REIT (or Real Estate Investment Trust) – pools the resources of investors together to buy a range of property assets, which the trust then manages for a profit. They are listed and can be exchanged on local Securities Exchanges. Also known as a listed property trust/fund.

Unlisted property fund – a form of property investment that provides investors the opportunity to gain access to commercial property assets through an investment in a fund.

WALE, or Weighted Average Lease Expiry – is the way to measure the average time period that all leases in a commercial property will expire.

Yield – a measure of returns to investors that is expressed as a percentage over a set period of time