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5 Things That May Affect the Return on Your Commercial Investment
Prime real estate in CBD and city fringe areas remain hot property for investors, and return on investment (ROI) is often the main driver of decisions. But how is ROI calculated and what factors can affect it?
Yield is an important calculation that tells you your rate of return as a percentage of your property’s cost or market value. It can be calculated in two ways:
Gross yield is the yield on an investment before fixed and variable costs. To work out your gross yield, divide your annual rental income by the total property costs. Multiply this figure by 100 to get the percentage value.
Net yield considers all the fixed and variable costs – including taxes, insurance expenses, general maintenance, and vacancy costs – that come with owning an investment property. It’s a more accurate way of determining yield but is also much harder to calculate as variable costs can be hard to predict. To work out your net yield, multiply your weekly rental rate by 52 weeks (minus your fixed and variable costs) and divide by the property value. Multiply this figure by 100 to get the percentage value.
Understanding the type of yield being calculated (and the types of costs being included and excluded) can help you decide whether to invest in a property. As a benchmark, commercial offices in the CBD and fringe areas currently average around six per cent yield. And, generally speaking, higher yields result in higher profits but come with greater risk.
Businesses incur two kinds of costs — fixed and variable. And commercial property is no different. So, when calculating the actual return on your investment, consider:
- Fixed costs – which include things like purchase expenses, stamp duty, insurance and taxes.
- Variable costs – which can include things like fit-outs, general repairs and maintenance, interest and loan repayments, loss of rental income (if the property becomes vacant), rates, and property management fees.
The main risk you take when investing in commercial real estate is vacancy. Vacancy rates fluctuate and are impacted by a number of factors including the size of the property, the lease and the market supply/demand. As a rule, the higher the vacancy rate, the lower the yield and the longer it will take to find a tenant.
While you cannot control fluctuations in market vacancy rates, you can reduce your risk for vacancy by securing a good, long-term tenant. Read more about how to secure the right long-term tenant for your investment property here.
4. TAX OBLIGATIONS
When leasing out a commercial property, there are various tax issues that can affect your return on investment. Consider:
- Capital Gains Tax (CPT) – if you lease out your commercial property and make a profit, a CPT is usually payable on the sale of your property. The amount you’re required to pay will vary based on the profit you made from the sale.
- Gearing – positive gearing occurs when the rental return is higher than expenses. If your property is positively geared, you will need to pay tax on the return you make. Generally speaking, a positively geared property has lower capital growth. Negative gearing, on the other hand, occurs when rental income is less than the expense of outgoings (like interest repayments and building maintenance). If your property is negatively geared, it means you are losing income and may be eligible for a tax deduction.
- Tax deductions – as a landlord, you can usually claim tax deductions for a wide range of expenses, including insurance, maintenance and repairs, loan interest and fees, rates, advertising and property management costs, and depreciation.
- GST – when investing, you may also need to register for GST. Visit the Australian Taxation Office (ATO) website for more information.
5. CAPITAL GAIN/CAPITAL LOSS
Capital gain is the profit you make from the sale of your property. Conversely, a capital loss arises if the proceeds are less than the price you paid. In your tax return, you can offset capital gains against capital losses.
If you’re looking to make substantial capital gains, invest in a property with room for improvement. But remember, you pay tax on your capital gains, and higher capital gains generally reap lower yields.
Remember, though return on investment is an important consideration when investing in commercial property, there are many other factors that need to be considered. If you’re a first-time buyer, educate yourself with these 5 commercial property tips for first-time buyers or use this checklist to make sure you’ve dotted your Is and crossed your Ts before you buy. You can also use this article as a guide to commercial real estate tax.
Already a seasoned investor? Find out why it’s important to diversify your commercial property portfolio.
TGC has access to a variety of office spaces in Sydney and an experienced team of commercial property experts who are happy to answer any questions. Contact us or call on 1300 458 800.
Not sure whether to buy or lease commercial property? Weigh up the pros and cons here.