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What is a good return on a commercial property?
Published
18 February, 2020
Commercial property investment is popular for those who want solid cash flow. And that’s typically what commercial real estate provides: strong, long-term income. But what is a good return on a commercial property?
Many investors will have different criteria for what a good return is on a commercial property:
- Yields must be higher than residential property investment
- Returns must be greater than the cost to finance the property
- The property provides an income to live off
- The return outweighs the risk of investing
Everyone is different. But the first thought in most investors heads when assessing a commercial property investment opportunity is yield.
What is yield?
Yield is the annual cash flow amount expected from an investment. It’s expressed in percentage form and is a huge driver for many investing in commercial property.
The term gross yield is used to describe the rate of return a property generates. It’s calculated as the rental amount paid by the tenant divided by the property value.
Net yield is the same calculation. But takes the rental amount after expenses and outgoings are applied (such as mortgage repayments and land tax).
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What is a good rental yield on a commercial property?
For commercial property investors, yields are typically much higher than residential property. Yields from commercial property can be anywhere from 5% to 10%. Meanwhile, residential property is known for yields between about 1% and 3%.
The main reason for the difference is found in the lease agreement.
Residential tenancies run for one or two years and rental payments are usually less than the amount owed to the bank. Meanwhile, commercial properties are occupied by businesses making money from the premises. Lease agreements run for multiple years (sometimes as many as 10 years) and rental payments from tenants are usually much higher than mortgage repayments owed to a bank.
Yields from commercial property can be anywhere from 5% to 10%. Meanwhile, residential property is known for yields between about 1% and 3%.
One tool to understand a good commercial property income is the capitalisation rate. The cap rate uses the net operating income of the property divided by its current market value to find the potential rate of return. Investors can use this formula to compare their property’s likely return to similar properties in the area.
What is a good capital gain on a commercial property?
On the sale of a commercial property, investors can be all smiles when calculating the difference in the amount they sold and paid for their property. This difference is called a capital gain (or capital loss, if the sale price is less than the amount purchased).
Many investors forget that commercial property can provide large capital gains. Check out our investment archives to see the 40% to 50% total return our sold properties have provided our investors.
To make sure the most profit from the sale of your property goes into your pocket (and not the taxman’s), investors should understand Capital Gains Tax (CGT). CGT is calculated on the difference between the sale price of your property and the costs to purchase, hold and sell it (called the cost base).
To make sure the most profit from the sale of your property goes into your pocket (and not the taxman’s), investors should understand Capital Gains Tax (CGT).
To understand whether your commercial property investment will provide a solid capital gain at the end of the day, it’s important to know how much CGT (Capital Gains Tax) you’ll pay on a commercial property investment.
What are your investment goals?
At the end of the day, a good return on commercial property depends on your goals. Are you hoping for an income to support you in retirement? Are you looking for a payout at the end of the investment’s life? Or perhaps you just want to offset the risk of investment (but don’t want the small returns of residential property investment).
No matter where you are in your commercial property investment journey, it’s handy to turn the complexities into simplicities. For more information on the returns you can expect from investing with a commercial property investment business, get in touch with us today.
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