Where should you invest when interest rates are high?

If you sigh every time you hear of another interest hike, you’re not alone. Australians are watching their loan repayments rise every month, and their discretionary incomes drop as a result. But if it’s income you need, what should you look for in an investment when interest rates are high?

Among other factors, you might look for yield. And if you need steady, positive cash flow, you need an income-producing investment that has a higher yield than the interest rate of your loan.

Residential property will rarely produce such yields, hovering around the 1 per cent to 3 per cent mark (while variable mortgage rates as at November 8, 2022, are around 5.2 per cent). But where many Aussies are turning for high yields is commercial real estate investment.

Strong income from commercial property

Commercial real estate investments typically generate yields between 5 per cent and 8 per cent, and sometimes a lot higher if the commercial asset is purchased extremely well.

Banks’ commercial lending departments do raise their interest rates on commercial loans, compared to residential funding, because there are a lot more complexities to grapple with when financing a commercial asset. That said, investors can still find loans with a 4.8-per cent interest rate. This puts them in a very good position to see positive net yields from their commercial tenant each month.

How does CRE produce such strong income?

Here’s a quick explanation of why commercial properties produce higher yields than residential assets.

Businesses are willing to pay more per square metre of occupied space than the average Joe or Jane Bloggs in the typical suburban property. These companies rely on their commercial space – whether an industrial warehouse, office premises or storefront – to conduct income-producing activities. And given the restrictions on conducting business in a residential property, they’ll pay a higher premium for the privilege to do so in a commercial space.

Now, to a degree, the smaller the tenant, the smaller the rent per square metre. A ‘mum and dad’ hardware store, for example, will pay a modest amount of rental for a modest amount of retail space. That’s because their requirements are unlikely to match that of a nation-wide retailer, like Bunnings. The commercial lease for a Bunnings is also likely to be far more complex than the same for a small hardware store, and potentially far longer.

There are many benefits to having a large, national or multi-national occupant in your commercial property investment. Your prosperity in commercial real estate really does come down to the quality of tenant occupying your space.

But isn’t commercial real estate expensive?

It certainly can be. Especially if a nationally operating business is occupying the premises, where you’ll be looking at a multi-million-dollar price tag for the underlying asset.

But if it’s yield you want and a ‘mum and dad’ hardware store won’t cut it, then you might consider what most commercial property owners do and invest alongside an unlisted property trust.

An unlisted property trust, or commercial property syndicate, pools the capital of multiple sophisticated investors to go after far larger, more profitable commercial assets than potentially possible if investing alone.

And it’s not just the solid returns that drive investors to find a reputable commercial property company to invest alongside. There are a tonne of benefits to investing in a commercial property syndicate:

• Set and forget investment
• Managed by real estate professionals with expert management and negotiating skills
• Mitigated risk
• Access to a vast league of commercial property experts (like leasing agents, selling agents, valuers, solicitors, etc)

With the ceiling on interest rate hikes yet to be seen for 2022/23, you might consider investing in a high-yielding investment to retain a positive cash flow. For us at Properties & Pathways, we find it difficult to look anywhere else for passive income than a robust, well-purchased commercial property.