Commercial Property. Explained. | A CBRE Private Wealth series

By Ingrid Filmer
Senior Managing Director, Capital Markets – Private Wealth, CBRE

Absolutely. Predictable rental growth is one of commercial property’s attractions. And depending on where the rent starts and how the market evolves, there may be even more opportunity ahead.

Imagine buying a commercial property with a lease that provides for a 4% rent increase every year.

The mechanism is already agreed. You can see how the contracted rent is scheduled to grow, helping you plan beyond the income you receive on settlement day.

On an illustrative starting rent of $100,000 a year, five annual increases of 4% take the rent to approximately $121,665. After ten increases, it reaches approximately $148,024.

That is the benefit of compounding. Each increase builds on the previous year’s higher rent.

But the annual increase is only one part of the investment story. Understanding today’s market rent, and what the premises might command in the future, can help you recognise additional opportunities.

Today’s rent can be tomorrow’s opportunity
The rent payable under an existing lease is known as passing rent. Market rent is what the premises could reasonably achieve in the current leasing market.

Those figures will not always be the same.

For example, you might buy a property returning $100,000 a year when comparable premises suggest a market rent of $110,000.

You receive the contracted income and benefit from the annual increases. There may also be an opportunity to capture the higher market rent when the lease allows a market review or a new lease is negotiated.

The timing and mechanism matter. An under-market rent does not automatically give the landlord the right to increase it immediately. Read the lease to understand when that opportunity could become available.

For an investor who understands the property and its market, that gap can be part of the attraction.

Think about the market in five or ten years
Commercial property is a long-term investment. Assessing its potential means looking beyond what a tenant would pay today.

A growing population, new housing, improved road access or a strengthening retail precinct can increase the appeal of a location. Limited competing premises and demand from operators can also support higher rents.

Consider fast-food property. A site with strong traffic exposure, convenient access and a well-positioned drive-through may become increasingly attractive as its surrounding catchment grows. If competing operators are willing to pay more for that location, market rental growth could outpace the fixed increases in the existing lease.

That creates a potential opportunity at a future market review or lease negotiation.

Using an illustrative example, a $100,000 starting rent becomes approximately $121,665 after five annual increases of 4%. If the market supports $135,000 by then, there could be further rental upside when the lease arrangements permit it.

The question becomes: what could this location support over the life of my investment?

How growing rent can build value
Rental income is a key driver of commercial property value.

A simplified valuation approach divides annual net income by the capitalisation rate, often called the cap rate.

For illustration, a property generating $100,000 in annual net income at a 5% cap rate has an indicative value of $2 million.

If its net income grows to $120,000 and the cap rate remains at 5%, the indicative value rises to $2.4 million.

That is a 20% increase in value driven by a 20% increase in net income, assuming the other valuation factors remain consistent.

This is why investors pay close attention to rental growth, market review provisions and the potential to improve a property’s income over time.

When income growth and yield compression work together
Value can also rise when buyers are willing to accept a lower return for the income stream. This is known as yield compression, or a reduction in the cap rate.

Buyers might place a higher value on a property following a new long lease to a strong tenant, improvements to the premises or stronger demand for its location. Broader investment and financing conditions also influence pricing.

If the property generating $120,000 in annual net income were valued at a 4.5% cap rate, its indicative value would be approximately $2.67 million.

Compared with the original $2 million example, both higher income and a lower cap rate have contributed to the increase.

Neither outcome is guaranteed. However, understanding both helps you identify what could create value and which improvements you may be able to influence.

Look for the whole opportunity
A fixed 4% annual increase is an attractive starting point. To understand the broader potential, ask:

• How does the passing rent compare with market rent?
• What could drive demand for these premises over the next five or ten years?
• When does the lease allow a market rent review?
• Could a lease extension, new tenant or property improvement strengthen the investment?
• How much of that future potential is already reflected in the purchase price?

The opportunity may be in the contracted annual increases, the ability to capture higher market rent in the future, or improvements that make the income stream more attractive to buyers.

Sometimes, it is a combination of all three.

Buying your first commercial property? Our Demystifying Commercial Property guide explains how rent, leases and yields work together, helping you recognise opportunities and invest with greater confidence.

Commercial property does not need to feel too hard. Follow the series and let’s demystify it together.