Dominant Pricing Metrics
Commercial real estate has been less liquid than residential property since COVID-19, as monetary stimulus from the RBA (Reserve Bank of Australia) between early 2020 and mid-2022 largely flowed into the residential property market. Amid heightened economic uncertainty, renting commercial property has been widely seen by business owners as a wiser choice than buying.
Herding behavior in residential property purchases has contributed to a “K-shaped” outlook in the broader real estate sector. Residential real estate has remained hot with buyers leveraging to make purchases, while commercial real estate has cooled due to weaker investor and business confidence.
The K-shaped trend in the real estate market has created significant challenges for price discovery in commercial properties. Pricing should incorporate market sentiment and economic momentum rather than depend solely on rigid assumptions about cash flows and property fundamentals.
Gross Rental Yield
Gross rental yield is a metric that measures the income return on a property investment before recognising any expenses. It represents the annual gross rental income as a percentage of the property’s market value.
Gross rental yield is widely applied by investors, brokers and property agents who constantly monitor changes in market sentiment. Thus, gross rental yield is strongly correlated with property transaction prices.
Capitalisation Rate (Cap Rate)
Capitalisation rate is a metric that measures the actual income return on a property investment after recognising all relevant expenses. Differing from gross rental yield, it deducts operating costs such as maintenance, management, insurance, government levies, and other property outgoings.
Capitalisation rate is predominantly used by property analysts and valuers, who place greater emphasis on a property’s future income, operating costs and key characteristics rather than short-term market sentiment. Capitalisation rate is sometimes referred to as the cap rate.
How to Apply? 6 Steps
Step 1: Identify all commercial properties of the same type as yours (e.g., offices, warehouses, retail shops, industrial units) leased within the past 12 months in the same commercial precinct.
Step 2: Calculate the rent per square metre (m²) for each property based on its total indoor area.
Step 3: Determine the average rent per square metre (m²) across all properties in your sample.
Step 4: Estimate your annual gross rent by multiplying the average rent per square metre by the total indoor area of your property.
Step 5: Search for the published 12-month gross rental yield for the commercial precinct, which is readily available on commercial property data platforms. Please reach out to us if you’re unable to find one.
Step 6: Estimate the market value of your commercial property.
Example (Demo Only):
| Property type: | Shop & Retail |
| Commercial precinct (if applicable): | UT Rosemont |
| Floor area: | 150 m² |
| Land area (if applicable): | 200 m² |
| Parking spaces (if applicable) | 2 spaces at the rear of the property |
| Year built | 2015 |
| Strata levy applicable | Yes |
| Annual outgoings (utilities, strata, maintenance, insurance, emergency services levy, council rate, land tax) | $15,000 |
Upon review, the following five retail shops in the UT Rosemont Precinct have entered into new lease agreements over the past 12 months.
| UT Rosemont Precinct | Annual gross rent (excl. GST) | Floor area (m²) | Rent per square metre (m²) |
| Retail shop 1 – UT Coffee Corner | $30,000 | 80 | $375 |
| Retail shop 2 – UT Bloom Florist | $43,200 | 135 | $320 |
| Retail shop 3 – UT Market Grocers | $95,000 | 250 | $380 |
| Retail shop 4 – UT Tech Electronics | $98,000 | 280 | $350 |
| Retail shop 5 – UT Fashion Boutique | $105,000 | 350 | $300 |
Another option is to consult real estate agents covering the commercial precinct for their insights on the prevailing average rent per square metre. Avoid relying on a single agent and try to consult multiple sources for a more robust assessment.
Data sourced from commercial property platforms indicates that the gross rental yield for UT Rosemont is about 5% per annum.
Performance appraisal:
If the property is financed through a loan (leveraged purchase), it is critical to compare the estimated capitalisation rate with the loan’s interest rate to assess the property’s capacity to service debt from its net operating income.
Risk arises when the capitalisation rate is below the loan interest rate, which implies net operating income from rents may be insufficient to cover its financing costs. This situation is referred to as “negative gearing.”
If the property is fully equity-funded (no loan), it is important to benchmark the capitalisation rate against alternative investment options to assess whether its income return adequately compensates for opportunity cost.
Given the prevailing K-shaped real estate market in South Australia, the estimated market value of $1,035,000 requires a liquidity discount. The liquidity discount accounts for buyer negotiation leverage in the current market. Based on our research, the liquidity discount is approximately 5–10%. It tends to be higher for older properties that require costly maintenance and insurance.
What We’ve Learned
(1) Commercial property relies more on rental yield than residential property, thus yield metrics are key factors in assessing market opinions on its “worth.”
(2) Development option (e.g., knock-down and rebuild) is another factor that significantly contributes to a higher or premium price.
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