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Why are more investors looking at commercial property?

A row of grey warehouses with blue doors and yellow and black safety bollards. Warehouses a popular choice for new commercial property investors because the entry point is low and the building is very simple to manage.

March 2024

It’s a trend we have noticed for a while now – we have been doing Depreciation Schedules on commercial and residential properties for over 20 years, so we pick up on trends.

Lots of investors start out with residential property and move into commercial. It’s almost like a residential property is investing with training wheels. We are all familiar with residential property, so it’s where we start.

Then many investors graduate to commercial property. Perhaps it is something you have thought about given you likely already have a residential rental property? Investors who move into commercial properties often wonder what took them so long.

Many get out of residential completely and just focus on commercial. Why might that be?

With residential property, the odds are increasingly stacked in the tenant’s favour. Leases tend to be 12 months at the most, owners need to pay council rates, insurance costs, often some utilities. And if the doorbell stops working, it’s your problem.

Let’s look firstly at the pros and cons of commercial properties.

Then, what are the types of commercial properties investors dabble in first?

And finally, how does depreciation differ with commercial properties?

Before we dive in, if you want to make an enquiry about a new commercial (or residential) Depreciation Schedule, call us on 1300660033, or enquire online.

A cafe owner opens the door to their cafe, welcoming guests in. The owner of the property can claim depreciation on the building and the fixed assets of the property.The pros of investing in commercial properties

In a general sense, the tenant in a commercial property is running a business from there so dealing with them is different from dealing with residential tenants and the leases are more complicated. It’s an idea to engage a commercial leasing agent as a go between – self managing a commercial property, your first one at least, would not be wise.

Because the tenant is running a business, they tend to take good care of the property – at their expense. And if the doorbell needs fixing, they’ll probably do it.

Commercial tenants often make improvements to the property at their expense to better enable them to run their business.

Your outgoings are something commercial tenants are accustomed to paying. Council rates, insurance, strata fees etc. Imagine not having to pay any of that.

Commercial leases are longer, which stands to reason – if somebody is going to go to the effort of establishing a business in a property they’ll want to stay there. Three years would be considered a short lease. Often they are five years or longer with option periods after that where tenants and landlords can agree on terms to extend the lease for another period.

That all sounds pretty good, huh. But for every swing, there is a roundabout. So best read on.

A ring of office blocks soaring into the blue skylines. Offices are similar to apartments in terms of depreciation, but one of the pros of owning an office, is that it can sit vacant longer than a residential property.The cons of investing in commercial property

The average price of entry can be higher than it is with residential property. And you might not be able to borrow as high a percentage of the property value compared with residential property. And the interest rate on the money you borrow will likely be higher.

Gulp.

Oh, and replacing a tenant can be more difficult when they move on. Offices, shops, small factories, all can sit vacant for months sometimes. And when you get a new tenant, it’s common for the landlord to give them a rent free period while they settle in and get established.

And they’re not as ‘liquid’. That means they can be harder to sell than residential property because there are fewer buyers.

But despite these cons, people are increasingly turning to commercial property. But what sort of commercial property? There are many types to choose from.

A small office with white walls with a full wall of windows with sun streaming through. There are white desks set up in the office, with black rolling chairs. Offices are a popular choice for property investors.What type of commercial properties do first time investors gravitate to?

We have done Depreciation Schedules on every imaginable commercial property. Everything from small shops to large farms. We even did a fish farm once.

Small offices in strata buildings are a popular choice for investors starting out in commercial property. They are not all that different from an apartment, so they’re easy for people to get their heads around.

And those strata fees in most cases will be paid by your tenants.

You’ll get a longer lease and likely have fewer headaches than with an apartment.

Then there are shops, either standalone ones or those in shopping centres. Sometimes these are bought by people so they can run their own business out of them, but let’s say you are just the landlord.

Tenant turnover can be a problem with shops – retail and hospitality are tough gigs. We all know shops that sit empty for ages and ones where tenants turn over regularly – it’s as if some locations have a curse on them.

And most of us have seen shops where there is a sign on the door saying the landlord has taken back the property. It’s a lot easier for a landlord to move against a commercial tenant compared with a residential one, but it’s still a big inconvenience. Sure, you might have locked out the tenant quickly, but perhaps being the owner of a chicken shop is not something you had planned.

Then there are small factories in strata complexes. Gee, we have a lot of clients buying these to rent out – often in their SMSFs. The entry point is often manageable and the buildings very simple – usually four walls with a mezzanine. Small businesses rent them sometimes just for storage. These are the properties we see more first time commercial investors target.

Grey carpet in a herringbone pattern in an office hallway. Carpet is an example of an Asset that can be claimed second hand in Commercial property, but cannot be claimed in a Residential property.How does depreciation differ with commercial properties?

The biggest difference is that the changes to depreciation in 2017 – gee, it seems a long time ago now – did not affect commercial properties.

Second hand Assets (also known as Plant and Equipment) in commercial properties can be depreciated. With second hand residential properties, it is just the buildings that can be depreciated.

That means if you buy a 10 year old commercial property, you depreciate the building and the air con, hot water, floor coverings, alarms, fire services etc. And if it’s in a strata complex, there is depreciation beyond the building – we wrote about this recently in a newsletter to our affiliate partners.

And if the building is used for ‘manufacturing’, you get to claim the building write-off at 4% as opposed to 2.5%.

So in general, there is more depreciation available in commercial property.

Questions about depreciation? Email Depreciator, the depreciation specialists, for the answer.Has this email reminded you about an investment property – commercial or residential – you need a Depreciation Schedule for?

Make a no-obligation enquiry online and rely on our 20-plus years of experience in estimating depreciation returns.

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What can be depreciated beyond a building?

A warehouse with blue trim and a large loading yard has significant concrete loading docks and a driveway shared by each of the owners. Each owner is entitled to claim depreciation on their share of this driveway, as well as their loading docks.

We’re not talking here about the Depreciating Assets, or Plant and Equipment, but we’ll touch on them – we have covered these previously.

We want to focus this month on the ‘structural improvements’, or Capital Works, additional to an actual building. Some Quantity Surveyors miss them, and that means your clients miss out on some depreciation.

And they can be missed in commercial properties as well as residential ones.

Why? Laziness, sometimes. 

A lack of understanding, perhaps? 

We’ve been doing this for over 20 years so we know what to look for. 

And when we inspect a property, we like to send a Quantity Surveyor there as opposed to a data collector. Call us old fashioned, but we think it’s best practice for the person who inspect the property to be the one who costs the Capital Works and values the Assets. 

Do you have a client with a property you would like us to tackle? Use your booking link or make an enquiry online.

Let’s look at commercial properties first. We are doing an increasing number of them – everything from small shops to large farms.

Key Points

  • Owners of shops and offices are entitled to claim depreciation on the common area Capital Works and Assets, e.g. underground carparks, foyers, elevators, etc.
  • Factories and warehouses are often part of a strata complex with fencing, lighting and security systems in the common areas.
  • Apartments can also have significant Capital Works deductions; they often have underground parking, gyms and pools and fancy roof top areas with BBQs.
  • ‘Hard Landscaping’ is Capital Works, but ‘Soft Landscaping’ can’t be depreciated so we separate out the hard from the soft in our Depreciation Schedules.

A row of shops with carparking out the front of each shop. Shops that are part of large complexes like this can have more opportunities to claim depreciation. Often, they are part of a strata complex, just like an apartment, and the owners are entitled to claim depreciation on the common area Capital Works and Assets.What gets missed with shops and offices?

We’ll tackle shops first.

Standalone shops are pretty simple. But shops that are part of large complexes can have more opportunities. Often, shops are part of a strata complex, just like an apartment, and the owners are entitled to claim depreciation on the common area Capital Works and Assets.

Think underground carparks, foyers, elevators etc. The Contract of Sale can be invaluable with these jobs.

And if the shop can be used for food prep and service, there is often a grease trap. Gee, a lot of people miss them.

Fitouts can also be tricky. If a client buys a property with a tenant in-situ and that tenant paid for the fit out, they would likely be depreciating it. But if the tenant has left and the fitout is still there, or if there was a landlord contribution for the fitout, the new owner of the property can depreciate it.

Similar opportunities are available for offices.

What gets missed with factories and warehouses?

Factories and warehouses are often part of a strata complex with fencing and lighting in the common areas and perhaps security systems and gate motors. There will also be fire services, drainage and concrete. Lots of it. And it won’t be the same as the concrete on your driveway at home.

Again, the Contract of Sale can be useful because it will often tell us about the common areas.

Even standalone factories invariably have a lot of concrete – you can read more on this here.

A sheep farmer leans on his gate as he overlooks his sheep in a paddock. Farms can have numerous buildings, some of which interestingly can be claimed as Plant and Equipment, such as a shearing shed.What gets missed with farms?

Farms are whole other thing and we can understand why most Depreciation Schedule providers avoid them, or do them badly. We do them often and have a Quantity Surveyor who knows more about cattle crushes and silos and goodness knows what else than he ever thought he would when he was a callow student many years ago. 

Farms can have numerous buildings, some of which interestingly can be claimed as Plant and Equipment. 

When is a shed not a building? When it’s a shearing shed.  A shearing shed is Plant and Equipment. Oddly, the Effective Life is 50 years, longer than Capital Works are typically, but because it’s Plant and Equipment, the DV rate is 4%. Or in some cases the Instant Asset Write-Off can be used.

When else is a shed not a building? When it’s a milking shed. Did you know there is also something called a ‘maternity barn’ on some dairies that is also Plant and Equipment – 20 year Effective Life.

And beyond the buildings, farms have culverts and dams and concrete channels. 

And of course there is all that fencing. Thankfully in most cases there is a paddock plan.

And all those cattle crushes.

Yee haa, cowboy!

A gym in an apartment complex with rows of treadmills. Apartments can also have significant Capital Works deductions; they often have underground parking, gyms and pools and fancy roof top areas with BBQs. What gets missed with residential properties?

We’ll divide these broadly into apartments and houses.

Apartments, like strata offices, can have significant Capital Works deductions beyond the apartment themselves. There is often underground parking, gyms and pools and fancy roof top areas with BBQs where residents congregate to look down upon the masses.

We very helpfully split the common Capital Works from the in- apartment Cap Works, as we do with the Assets. Other providers don’t do this.

Houses are easier, of course. But there is still fencing and driveways and often retaining walls. There can be pergolas and elaborately constructed BBQ areas  And what about landscaping?

‘Hard Landscaping’ is Capital works, but ‘Soft Landscaping’ can’t be depreciated. That’s because depreciation is driven by Effective Lives. A concrete path has an Effective Life of 40 years, but a geranium, say, does not have an ATO Effective Life. So we separate out the hard from soft landscaping.

There are also houses that are part of gated communities. They can be trickier as owners often pay levies for the upkeep of roads, tennis courts and pools etc, so we can often depreciate them.

Questions about depreciation? Email Depreciator, the depreciation specialists, for the answer.If you have a client we can help with claiming depreciation, please use your booking link, or make an online enquiry.