10 Step Commercial Property Due Diligence Checklist for Beginners

Investing in commercial property can be a natural investment ‘stepping stone’ from residential property to diversify your portfolio. But for a first time buyer, navigating the process can be complex, which is why a due diligence checklist is vital.

Simplicity Loans & Advisory general manager Ryan Nelson said in a nutshell, commercial property was a materially different investment to residential, which carries a different degree of risk.

Before taking the leap into your first commercial property buy, here are 10 things to take into account:

1. Investment objectives

Before purchasing any commercial property, buyers need to have absolute clarity around their investment objectives, says Daniel Wolman, Cushman & Wakefield Australia’s head of investment sales and international director.

“Whether the focus is on generating stable income, achieving capital growth, or securing a future premises for occupation, that objective should drive every decision,” he said.

“Equally important is understanding the intended holding period and how the asset aligns with the investor’s risk profile and exit strategy.”

2. Assess location and demographics

Just like residential property, location is important when investing in commercial real estate because it is one factor you cannot change, Raine & Horne executive chairman Angus Raine said.

“An attractive commercial property has easy access to key transport links, and is ideally located close to a nearby population hub, which will supply a workforce for tenants,” he said.

3. Understanding how a commercial loan works

Simplicity’s Mr Nelson said compared to traditional home loans, there were nuances in the process of attaining commercial property finance.

“We’re talking in the same orchard, perhaps, but… (it’s) not apples with apples,” he said.

Simplicity Loans’ general manager Ryan Nelson says residential vs commercial loans is like comparing apples with oranges. Picture: Supplied

To begin with, GST is typically applied on a commercial property purchase, which buyers might be able to claim back but it needed to be budgeted for upfront.

“Banks typically lend 60-70% of a commercial property’s value, making a substantial deposit (or equity equivalent) essential,” Mr Raine said.

4. Lease terms and expiry profile

The lease is effectively the backbone of a commercial property’s income stream, says Cushman & Wakefield Australia head of investment sales international director Oliver Hay.

“Investors should carefully review lease terms, expiry dates, renewal options, rent review mechanisms and any make-good obligations,” he said.

“Particular attention should be paid to assets where multiple leases expire simultaneously, as this can increase vacancy risk.”

5. Understand the yield

Commercial property yield is determined by dividing the property’s annual rental income by its purchase price or market value, expressed as a percentage.

In general, commercial yields are higher than residential yields, which can make commercial property an attractive source of ongoing income.

“However, buyers need to understand how yield works in terms of a property’s location and quality,” Mr Raine said.

“As a guide, prime CBD assets with blue-chip tenants carry lower risk and often have lower yields, while regional or secondary properties carry higher yields to compensate for higher risk.”

Raine and Horne chairman Angus Raine said Budget changes would direct more investors to commercial assets.

6. Vacancy and reletting exposure

Even the strongest tenancy profile will eventually change, Mr Hay says, and buyers need to understand how readily vacant space could be re-let and factor in the potential costs of leasing commissions, incentives, downtime and fit-out contributions.

“These costs can have a meaningful impact on overall cash flow and investment performance,” he said.

Leverage is important – buying a building with only one tenant may be riskier than buying a property with multiple lessees, Mr Raine added.

“In either case, consider how long the tenant has been in business – and importantly, think about whether it is likely to enjoy longevity in today’s fast-changing world,” he said.

In the commercial sector, there is an opportunity to “look a little bit deeper into the tenant” to form a view on them as a business, Mr Nelson says.

“Are they a strong tenant whose brand name has been in the premises for a long period of time? Or are they a start-up in an industry that you don’t know so much about?”

“You get the opportunity of a little research on that in commercial, which is very different than resi, where it’s a name, a number, and an agent telling you they’ve got a good job.”

Choosing the tenant is just as important as the building itself as it can make or break your investment. Picture: Soeren Bidstrup / Ritzau Scanpix

7. Building condition and future expenditure

Many first-time investors focus on the income stream but overlook the physical asset itself, according to Mr Wolman.

“Obtaining building and compliance reports can identify future capital expenditure requirements, environmental considerations and potential maintenance liabilities that may materially affect investment returns over time,” he said.

8. Opportunities to improve yields/enhance capital value

Commercial property is not a ‘set and forget’ investment as it requires ongoing due diligence so that you continually maximise its investment potential.

“As a guide, an over-sized parking area or unused land that is part of the property allotment can offer scope to add additional lettable space, and enhance long term value, Mr Raine said.

“Other ways to improve yields may include allowing advertising billboards on the building or leasing rooftop space to telecommunications providers for mobile phone towers.”

9. Assess the specific asset class

Multiple sectors make up the commercial property sector, which typically includes office, industrial or retail but there are additional sectors including hospitality, aged care, and childcare.

Mr Raine said each sector had its own nuances, tenants’ requirements and market influences.

“For first-time commercial property investors it is worth deciding which sector you wish to target,” he said.

The three main overarching asset classes include retail, office, and industrial with many sub-sectors throughout.

An office investment in the CBD versus an office investment in the suburbs were remarkably different assets post Covid, Mr Nelson says.

The industrial sector traditionally performed well, strongly driven by e-commerce, he added.

“Retail’s a challenge in most instances, but maybe not neighbourhood or strip shops … it’s not necessarily a class that people go aggressively into.”

“Something that’s really popular at the moment is childcare, or service stations to a lesser extent – those kind of specialised assets.”

The trade-off is that steadier, more defensive investments can carry higher price tags and investment demand may make it harder to crack into when you’re up against high net worth bidders or investment firms.

10. Title, planning and permitted uses

Mr Hay said while an asset might appear attractive on face value, title restrictions, zoning controls and planning regulations could significantly influence both current operations and future opportunities.

“Understanding these factors is essential when assessing flexibility, redevelopment potential or alternative uses for the property,” he said.