A friend invests in commercial property and his minimum is 6% to make it worth his while. I must admit I was interested that commercial properties can come with guaranteed yields, with long-term leases in place. Of course that is not forever, but a solid foundation.
Having been advising landlords and investors (same thing really) in the commercial property market for about 47 years (excluding the first 5 years of my working life when I worked for a multi-disciplined firm of surveyors and wasn't allowed to advise unaided) and having written extensively about successful investment in commercial property (England and Wales only : the law in Scotland differs), I don't profess to know it all but this I do know:
Comparing yields from different types of property investment is a waste of time and pointless. Commercial property is an umbrella description for lots of different sectors and segments, each of which having their own characteristics, With commercial property (if not residential as well) yield (normally gross, unless otherwise states) is normally expressed as gross yield.
The commercial property is not one big market: there are regional variations and location variations The principal adage is location, location, location. Yield is the relationship between the rental income and purchase price. But yield is also another way of expressing years purchase. ie, the number of years before one gets one's capital back. YP is calculated by dividing 100 by the percentage yield. for example, 7% would be 14 yp approximately. When assessing yield without remembering the yp, the fact that anything can happen over the number of years can get overlooked.
Unlike residential property which normally fetches a higher price with vacant possession than if let, commercial property normally fetches more when let. However, buying a commercial property that is already let is a depreciating asset because the purchase price is based upon the security of the rental income at the date of purchase. The security includes the certainty of getting the rental income which is why the tenant's covenant is also important. For example, a lease for 10 years remaining is worth more than a lease with only 3 years remaining but 10 year let to a run-of-the mill local tenant might fetch less than 3 years to a nationally-known covenant For the investment to hold its value, the rate of depreciation requires an equivalent rate of appreciation.
The rate of appreciation depends upon rental growth and when Base Rate is high on the prospects for yield compression, having regard to normal borrowing rates. With Base Rate at 0.1% and yield compression factored in, commercial property investment could be said to be priced to perfection.
Rental growth is a product of supply and demand. However, supply isn't the same as suitability. whether a tenant would pay a higher rent depends.
Unlike residential buy-to-let where tenants generally have to fend for themselves over rent increases etc, tenants of commercial property are often advised by surveyors, such as myself. When I act for a tenant of a commercial property, my job is to prevent the landlord getting what it wants by enabling my tenant client to get what it wants. Vice versa when I act for the landlord. Although the relationship between landlord and tenant of a commercial property should be a partnership, in practice it is predominantly confrontation. The outcome of a rent review and lease renewal can make or break the landlord's investment, so to the tenant's business.
Unlike residential BTL where an Assured Shorthold Tenancy agreement is a standard document that can be tweaked to a limited, there ks no standard form of lease common to all landlords and tenants of commercial property. A lease is drafted from scratch, albeit template exist but the terms and conditions of a lease can be changed depending whatever the parties would agree. There is some overriding legislation but a business tenancy is a commerfcosl contract which means the parties are deemed to know what they are doing.
Objectively, the value of a commercial property investment is the capital value if the passing (current) rent plus the capital vale of the estimated rent at the next rent review or lease renewal deferred by the number of years before that review / renewal.
Although yield compression - and yield expansion as evidenced by lower valuations for quoted prop co NAVs - has introduced another way of thinking into the valuation process, in principle the higher the yield at the outset the lower the prospects for rental and capital growth.
If you buy a commercial property that is vacant ti be begin with with a view to letting it, how long it might take to find a (suitable) tenant depends. I say 'suitable' because it might not pay to accept the first one that comes along. even if you do the. chances nowadays of a tenant wanting to commit for more than about 5 years or without a break clause are slim. Generally, it is restaurant tenants that prefer longer leases because that enables to write down the value of capital expenditure over the term.
Give the permutations that exist, successful investment in commercial property may be summed up in two words: judicious choice. In other words, were and what to buy, when to buy, how to manage and capitalise on the relationship with the tenant, when and how to sell.