Investing in retail is one of my favorite types of commercial to invest in. I love finding a strip of shops that has a variety of different shops and is surrounded by a large chunk of residential.
If an area has, for instance, a few cafes, and the other regular daily use shops like a bakery, hairdressers, estate agents, supermarket, bottle shop, etc. these can be local hubs for residents of the area who like to shop and eat locally.
Many estate agents will advertise that a house is in a cafe precinct, the cafe lifestyle, and convenience of those shops, so nearby to a home is a big selling point.
If a commercial area like this is fully surrounded by residential, then the chances of that retail area expanding are slim. Of course, it’s worth checking in on the local zoning so see that no more land is zoned for commercial business.
What this will mean is that those shops are never likely to go untenanted for very long, if at all. This makes owning a shop in this area a fairly safe bet.
Like in all markets supply and demand runs to the prices of things. The downside of buying a shop in an area where demand will be high and supply low is that the capitalisation rate for any properties on offer will be lower than in other areas.
If you were to buy in an area like this, you might only get a cap rate of say 4% this means you are paying more for the property, and your return on investment when buying this property is going to be lower.
I usually talk about much higher cap rates than this but just because you are looking at a property at a 4% cap rate doesn’t mean it’s going to stay like that.
I saw a property in Bondi go recently for a 4% cap rate. It was a shop with an apartment upstairs. If you were to buy this property, there is nothing saying that you have to rent out the upstairs to a residential tenant.
You could in increase your return but letting out the apartment as serviced letting for instance. There are many strategies you can use to increase your returns. Since commercial values are based on the value of the lease, using these strategies to increase your returns is also going to increase the value of the property.
It’s worth looking at the shopping strip at different times of the day and different days of the week to see how the traffic and business of the retail area changes during the week, this could highlight strengths and weaknesses that would be good for you to know.
The next stage is looking further at the area to see what other plans the council has for the area. Do your due diligence on the property, the tenant, the lease and even chat to the tenant to see if they are interested in staying on and signing a new lease that could serve you both once you buy.
Imagine you are looking at a property where the tenant has a 3+3 year lease, and she is halfway through the lease. Her business is doing well, and she is keen to stay and continue to grow her business.
Let’s say you offer her a 5+5+5 year lease starting from the day you settle on the property. Now she’s even more secure in her business, and the banks are going to value your property higher because all of a sudden you have a stronger lease and a much longer WALE (Weighted Average Lease Expiry).
While I like cafes and residential upstairs (I have several in my portfolio) and this gives me an insight into what to look for in a potential new investment that has a cafe tenant, this is not to say that you should only look there.
I have students that love industrial and have become experts in this arena. Others that love investing in showrooms/warehouses.
The thing is that the more you specialise in a particular area and ask questions and learn the best ways to expand the income from a property, the faster you will be able to grow your portfolio.