Over the past decade, and especially over the past five years, there has been a significant increase in the number of commercial buyer’s agents in Australia.
Many are actively promoting the benefits of investing in commercial property. And with higher interest rates reducing borrowing capacity, more investors are being tempted to consider commercial property as an alternative to residential property.
On the surface, the pitch is compelling: higher rental yields, tenants typically pay most property expenses, and there is still the potential for capital growth.
At the right price, commercial property can be a very attractive investment. But overpaying for any asset is always a recipe for poor outcomes. And in my view, that is the biggest risk facing commercial property investors today – valuations look very stretched.
Commercial property being marketed as an alternative to residential
With higher interest rates over the past 3 years, tighter residential tenancy laws and rising property taxes, more investors are considering small, single-tenant commercial properties. This includes specialised properties such as childcare centres, fast-food premises and medical suites.
These properties typically cost between $1 million and $5 million, with gross rental yields often ranging between 5% and 6%. In most cases, the tenant pays most outgoings. Such investments are commonly located on the outskirts of capital cities, or in regional cities and towns.
Social media is full of commercial buyer’s agents promoting these investments, often supported by attractive projected future returns. However, much of the recent performance has been driven by increased investor activity and an unusually strong rise in industrial land values.
According to Knight Frank, industrial land values on Australia’s east coast increased between 46% and 131% over the five years to mid-2025, depending on lot size and precinct. However, growth substantially plateaued through 2024 and 2025.
That context matters. When an asset class has enjoyed unusually strong, and likely unsustainable, recent growth, historic returns can look very compelling. But that does not mean they are repeatable.
Commercial property is valued on a cap rate
Commercial property is typically valued using a capitalisation rate, or “cap rate” for short. The cap rate reflects the income return an investor expects to receive from a particular commercial property.
Lower-risk assets tend to attract lower cap rates, and higher-risk assets should attract higher cap rates. For example, a property leased to a blue-chip tenant on a long, secure lease would generally be considered lower risk. Its future cash flow is more predictable, so investors are usually willing to accept a lower return.
Recent auction data from 2025 suggests commercial property yields/cap rates in Sydney, Melbourne and Brisbane are typically between 5% and 6%. Some of the prices being paid today are difficult to justify. At a Burgess Rawson auction in June 2025, a McDonald’s in St Albans, Victoria reportedly sold on a 2.92% cap rate, setting a national record for a ground lease (landlord owns the land but not the building). A KFC in Sydney sold on a 3.18% cap rate. Both yields are materially below the 10-year government bond rate. In other words, investors are accepting less income than they could earn from a risk-free government bond, presumably because they expect future capital growth and increased rental yields through CPI to compensate them. That is a big assumption.
However, these are gross headline yields. The actual return to investors can be materially lower once you allow for buyer’s agent fees, stamp duty, due diligence costs, legal fees, potential vacancy, future capital expenditure and leasing incentives at renewal.
Depending on the property, these costs and risks could easily reduce the headline yield by more than 1%.
Therefore, the true adjusted yield, or cap rate, may be closer to 4% to 5%. That is not a particularly generous return for the level of risk being taken, especially if leverage is involved.
In that situation, investors must be confident that the property can also deliver long-term capital growth of, say, 4% to 6% per annum. Otherwise, the total return may simply not justify the risk.
These yields look low by comparison
Historically, commercial property has largely been an income-style asset. In other words, most of the return tends to come from rental income, with long-term capital growth typically averaging around 3% to 4% per annum.
Because of this, commercial property should be compared to other income-producing assets to determine whether current pricing is attractive.
For example, bonds issued by some of Australia’s major banks are currently yielding between 5.75% and 6.4%. These bonds are A-rated subordinated debt, meaning the risk of default is extremely low.
Compared to commercial property, these are very low-risk investments. So theoretically, if an investor can earn 6% from a high-quality bond, then commercial property should offer a meaningfully higher return to compensate for the additional risk.
Similarly, I am aware of an unlisted commercial property fund that owns office buildings leased entirely to federal and state governments. The fund currently pays a distribution yield of 8% p.a. and is valued on a cap rate of 7.2%.
Importantly, this fund owns multiple properties, providing diversification, and is around 99% occupied, and has secure government tenants.
If a diversified, institutionally managed fund with high-quality tenants is being valued on a 7.2% cap rate, then arguably a small, single-tenant commercial property carrying materially higher risk should be offering a significantly higher return than that benchmark.
Historically, where should cap rates sit?
In the late 1990s, commercial property cap rates were relatively high. Secondary industrial property typically traded at a spread of 3.5% to 4.5% above the 10-year government bond rate. In practical terms, headline yields on secondary stock were often around 10% to 11%.
During the pre-GFC credit boom, cap rates compressed sharply. By the cyclical peak in early 2008, secondary industrial spreads had narrowed to around 1.5% above the 10-year bond rate. That proved unsustainable once the GFC arrived.
After the GFC, spreads widened materially. Secondary industrial property typically traded around 4% to 5.5% above the government bond rate through to approximately 2014.
At the start of Covid, secondary industrial cap rates were around 6% to 6.5%. With the 10-year bond rate at roughly 1%, this implied a spread of approximately 5% to 5.5%.
By late 2021, bond yields remained low and capital continued to chase industrial property. Secondary industrial yields compressed to around 4.5% to 5%, and the spread to government bonds narrowed to approximately 2.7% to 3.3%.
Since then, the 10-year government bond rate has risen from around 1% to approximately 5%. However, secondary industrial cap rates have not adjusted by anywhere near the same extent. They widened by roughly 1.5% to 2% through 2022 to 2024, before tightening again in 2025.
As a result, the headline spread between secondary industrial cap rates and the 10-year government bond rate is now only around 1% to 1.5% – which is like what they were pre-GFC.
Historically, it would be reasonable to expect secondary industrial cap rates to sit around 3.5% to 4.5% above the government bond rate. In today’s environment, that would imply cap rates of approximately 8% to 10%.
Instead, much secondary industrial stock is still trading on cap rates between 6% and 6.5%. That is well out of step with historical ranges and looks expensive. It also compares poorly with lower-risk income-style assets, such as bonds and diversified property trusts, as noted above.
Why haven’t cap rates adjusted?
Why have commercial property cap rates not widened in line with the circa 4% increase in 10-year government bond yields since 2021?
In my view, two demand-side factors explain most of it.
First, higher interest rates have reduced residential borrowing capacity by roughly 30% since 2021. Many investors who might previously have bought another residential property are now priced out of metropolitan markets. As a result, some have rotated into small-lot commercial property, where the entry price is lower and SMSF borrowing remains available.
Second, the commercial buyer’s agent industry has grown materially over the past five years. Social media has helped manufacture demand at scale for what remains a relatively thin-supply asset class.
The result is that cap rates have stayed artificially compressed. Not because fundamentals justify current pricing, but because demand has been supported by these two structural forces.
Neither is permanent.
If borrowing capacity recovers, demand for commercial property may fall. And if buyer’s agent-driven demand fades, the valuation problem could become apparent very quickly.
What drives changes in commercial property values?
There are three main factors that can influence the value of a commercial property.
Here’s a clearer version in your style:
The first driver is the amount and quality of the rental income. Quality refers to the strength of the tenant and the reliability of the cash flow.
All else being equal, as a property’s rental income increases, so too should its value. Many commercial leases include fixed annual rent increases to help keep pace with inflation. In some cases, particularly in retail property, rent may be linked to the tenant’s turnover. This means that if the tenant’s business performs well, the rental income can increase significantly, which in turn can lift the property’s value. However, the reverse is also true, as weaker business performance can result in lower rental growth.
The second is the underlying land value. This can be particularly important if the site has alternative uses. For example, a commercial property that could eventually be redeveloped into a higher-value use, such as residential apartments or a mixed-use development, may be worth more because of its land value.
The third factor is the capitalisation rate, which reflects investors’ return expectations. If cap rates fall, property values rise. But if cap rates rise, values will fall.
What happens if cap rates revert to the mean?
As the table below illustrates, an investor who buys a $1.5 million commercial property on a 6.5% cap rate and borrows 70% could see most, if not all, of their equity wiped out if cap rates revert to their long-term average.
In that scenario, the downside is severe. No amount of rental income would make that risk look attractive. Of course, if the 10-year government bond rate falls materially in the short term and commercial property cap rates remain unchanged, then the risk of commercial property values declining would be significantly reduced.
| Reversion to | Asset price | Asset loss | Equity remaining | Equity loss |
| 7.0% | $1,392,857 | ‑7.1% | $342,857 | ‑24% |
| 7.5% | $1,300,000 | ‑13.3% | $250,000 | ‑44% |
| 8.0% | $1,218,750 | ‑18.8% | $168,750 | ‑63% |
| 8.5% | $1,147,059 | ‑23.5% | $97,059 | ‑78% |
| 9.0% | $1,083,333 | ‑27.8% | $33,333 | ‑93% |
| 9.5% | $1,026,316 | ‑31.6% | ($23,684) | ‑105% |
Changes in negative gearing may stretch valuations even further
If negative gearing is abolished for existing residential properties, more investor capital may be redirected into commercial property.
That could place further upward pressure on commercial property values and compress cap rates even more, despite valuations already looking stretched compared to historical levels.
If that occurs, the opportunity to invest in commercial may become riskier.
Value aware: Quality at the right price
Commercial property certainly has advantages, and many investors have built substantial wealth by owning it, including myself.
However, the same rules apply to commercial property as any other asset class.
It is important to buy a quality asset with strong underlying fundamentals, using an evidence-based methodology. But it is just as important, if not more important, to buy that asset at a price that makes sense.
This is what I refer to in my new book, Wealth by Design, as a value-aware asset allocation strategy.
At this stage, the prices being paid for many commercial properties do not make sense to me when compared with historical valuation measures and alternative income-style assets.
As such, I think the risk is too high. The risk of valuations reverting to their long-term average is significant, particularly for an asset that is usually acquired with leverage.
