Estimating buy price - Part 2 [Archive] - Somersoft Property Investment Forums

Mike

07-10-2002, 09:33 AM

Hi Folks,

I'm starting a new thread for the second exercise because the first thread is already long enough and besides the method for calculating the value of a commercial property investment is different to that of a residential property chiefly, I think, because the risks are greater. (I just gave you a clue.) Perhaps that may be a point of discussion later in this thread but first have a go at this exercise.

How to calculate the rent and value of a shop.

An investor is looking to purchase a shop in a prime retail street location and wants to calculate what the rental income should be and how much the shop is worth. The investor finds a suitable shop (Shop D) which is to be sold at auction shortly. Having researched previous sales in the area the investor chooses three shops (A, B, C) to compare which have sold in the same street in the last month. The following comparisons are noted:

1. All 4 properties are in identical positions; are held on identical leases; and have been maintained in good order. (Point of clarification: Take "identical leases" to mean identical length of term. Shop D which is the target shop is being sold without a sitting tenant. But the investor is simplifying the adjustments by choosing the same lease term as the other shops have.)

2. No adjustment is needed to compare: position; date of the transaction; differences in tenure; and condition.

3. However, the shops are different in size and the quality of the covenants of the tenants varies. ("Quality of tenant covenants" could be a point for discussion, however, for the purposes of this exercise I'm happy to simplify this to mean quality tenants. You will have to exercise your own judgement on what constitutes a quality tenant.)

Shop A:

Floor area is 74 sq metres;
Rent is $16,000;
Tenant is a National franchisee;
It sold subject to the tenancy for $232,000

Shop B:

Floor area is 102 sq metres;
Rent is $23,000;
Tenant is a popular local baker;
It sold for $255,000

Shop C:

Floor area is 140 sq metres;
Rent is $32,000;
Tenant is unknown and of doubtful quality; (Perhaps is an independent retailer of second-hand books with no profile.)
It sold for $228,500.

Shop D:

To be sold at auction shortly
Floor area is 116 sq metres;
It is in good repair.
Not currently let so rent is unknown.
Price: ?????????

Please answer the following questions:

What rent can be expected for Shop D?

How much is it worth?

When determining the worth of the shop I'd like you to take into consideration the fact that you have found a tenant who will move in within 6 months if you purchase the property. The tenant is a local retailer who has a chain of 12 shops.

Good luck, hope you get the property at a reasonable price.

Regards, Mile

PS: The link to Estimating buy price - Part 1 is: http://www.somersoft.com/forums/showthread.php?s=&postid=1147#post1147

geoffw

07-10-2002, 12:04 PM

This is a bit of a new world for me, so I'd just be guessing...

Rental per square metre seems to be fairly constant (between $216 and $228). If I took a figure of $220 per square metre, I'd guess rent would be around $25,520 pa.

Rental returns appear to be based on risk. Return is 6.9% for the franchise, 9% for the baker, and 14% for the dodgy shop.

I don't know if I have to factor in 6 months vacancy into the equation before the tenant moves in. It may be worth a higher price to negotiate a longer settlement- I'd end up paying less if I could settle just before the tenant moved in.

I guess I'd be putting the new tenant into the same risk factor as the baker- that's more stabbing in the dark for me. If that were the case, a 9% return would indicate a price of around $283,500.

geoffw

07-10-2002, 01:11 PM

Actually, thinking about that...

$283K?

I could offer $20K above purchase price to the owner of shop C (Making $248K), and make a cash offer to Mr Dodgy Tenant (whose business is probably in trouble anyway) of say $10K- and be way ahead on the deal. Mr Dodgy would have 6 months to vacate. Even offer Mr Dodgy 6 months rent free- which is what you would have been forgoing on the other shop anyway.

You'd be able to get a good idea of the viability of the business with some observation, which could give you some negotiation power.

geoffw

07-10-2002, 07:07 PM

Anybody else out there?

I've been thinking about this (most strange)...

I've probably diddled myself big time in my price estimate. I'm estimating the price based on a tenant who I have arranged. The place is being sold as untenanted. And I'm buying it with a price which is dependant on the reliability of the tenant I'm arranging. So IF the price is dependant on a tenant's reliability, and it's empty, I have no comparable figures- so can't really estimate, I don't know what an empty place is worth on figures given. But certainly a lot less than my estimate.

asy

07-10-2002, 07:58 PM

Nobody else is out here geoffw...

we are hiding under rocks amazed at your effort... :D

Actually, I have been trying to get to doing the math all day...

I think you have done it the way I would have (really!!) :p

The only other factor I can think of is location within the strip, ie, closeness to corner, proximity to major stores (next door to K-Mart for example) , availability of street signage, proximity to parking, etc.

Mike, you said:
All 4 properties are in identical positions

Interesting.

Is there such a thing as 'identical positions'?

I understand what you meant, that the position should not be a determining factor in the price consideration, but it begs a discussion, I thought. I don't believe there is such a thing as identical positions. Even two houses next door to each other, will have a favouritism for different ppl depending on their wonts.

This would be the same for retail property.

Imagine that there are two stores, each 100m2, next door to each other, with the same dimensions, and the same style of facade. Why would a retailer choose one over the other,assuming all costing factors were identical?

I believe that the factors I mentioned above would come into play.

Is one closer (or maybe backing onto!) car parking?
Is one closer to the corner, and therefore more visable to oncoming traffic?
Is one directly in front of the bus stop? (this can be good- ppl getting on and off the bus must look at your facade or bad- the bus stop may obscure your signage).
Is the local Target store next door to one of them?

Interesting, this property game, isn't it??

Maybe that's why I love it so much!!!!

asy :D

(I am still trying to get to that math!!! :p )

Mike

07-10-2002, 08:28 PM

Hi Asy,

Good post. This is the kind of thoughtful discussion I hoped would be raised in this thread. It would be pointless to make it just an exercise in maths. It's all about learning so if anybody has any real-life experiences, please share it with us so we can all learn something.

However, for the sake of simplicity, take "identical positions" to mean that no shop is advantaged more than the others as far as passing trade or parking restrictions is concerned. As Asy rightfully concluded these factors would have to be considered in the worth of any commercial property.

Regards, Mike

PS: Don't be put off by Geoff's bid. The temptation may be to put in a higher bid to get the property. That's real life. But the purpose of this exercise is to get an accurate estimation of the property value. After all the bids are in then will we see that some people were prepared to pay more than others. It could eventuate that all the bids are below the answer that I have which means somebody got the property for a good deal. Or, it could turn out that everyone bid above the answer which means the highest bidder overpaid. Some people may think my answer is wrong or unrealistic. Well, I'm hoping some good discussion will come from it, anyway, which is the point of this thread.

Les

07-10-2002, 09:49 PM

G'day GeoffW,

Your thoughts certainly struck a chord with me - reminded me of a Dolf de Roos story wherein he bought a funeral parlour - he only bought it because he ALREADY had a renter. And it was For Sale CHEAP because nobody else had found a tenant !!!!!

And your thought of involving Mr Dodgy in a deal sounds to me like a smart way of thinking!! I might use some of these ideas to come up with a purchase offer.

A bit more ruminating time required .....

Thanks for your thoughts - you hadn't patented them, I hope ;)

Lissy

07-10-2002, 10:27 PM

My brain hurts.... ;)

Mike

07-10-2002, 11:03 PM

Hi Geoff,

I applaud you for being first up. The exercise is not easy because you have to make a guesstimate on the quality of the tenant which translates into a yield figure. If you use yield to get the property value then it's obvious that a correct determination of what constitutes a quality tenant needs to be addressed. It is obviously not just about what term they are prepared to lease for. In our example, we assume that all shops have identical lease terms, yet, the quality of the tenants are different and this seems to have an effect on the value of the property.

Reading Warren Buffet's ideas on buying good businesses might help in this regard. One of the more obvious factors that determines a good business is, "How long is it going to stay around?" Seems like a popular baker is going to do good business and make good profits because people understand his products. The baker is less likely to need expensive marketing campaigns or to re-invest profits in plant upgrades. Some franchises, however, may have slimmer profit margins because the nature of the business requires higher capitalisation.

You also said: I don't know what an empty place is worth on figures given. But certainly a lot less than my estimate. You haven't given a final bid price, then, if you are correct that the value should be discounted because there is no sitting tenant on a long-term lease. You seem unsure whether to discount or not because you have a good tenant lined up but there is a possibility that they won't start a lease for 6 months or they might change their mind and not lease at all. Should we discount the value based on all this uncertainty?

On a different point of discussion: Is there anything wrong with using 'Price per Square Metres' as a way to calculate value?

Shop A: Price = $232,000; Floor area = 74 sqm; therefore, PpSM = $3135

Shop B: Price = $255,000; Floor area = 102 sqm; therefore, PpSM = $2500

Shop C: Price = $228,500; Floor area = 140 sqm; therefore, PpSM = $1632

Total value = $715,500
Total Floor area = 316 sqm
Avg PpSM = $2264.24 per square metre.

Shop D has a floor area of 116 sqm, therefore, 116 X 2264.24 = $262,652

To confuse matters, is the above method for calculating Avg PpSM correct? Or is it better to calculate individual averages first, then get the average of the 3 averages?

Shop A: $232,000 / 74 sqm = $3135 PpSM

Shop B: $255,000 / 102 sqm = $2500 PpSM

Shop C: $228,500 / 140 sqm = $1632 PpSM

Total PpSM = $7267
Avg PpSM = $7267 / 3 = $2422

Shop D has a floor area of 116 sqm, therefore, 116 X 2422 = $280,952.

The second calculation is $18,000 higher simply due to the way I calculated the average price per square metre. One of these methods must be adding a margin of error into it. Can anybody tell me which method is better?

I'm not saying this method is right but it does average out known factors such as Prices, Floor Area, and even the Quality of the tenants as reflected in the Prices. Of course, the price here is based on shops with tenants. A discount factor may still apply to Shop D because it has no tenant, yet. Any comments?

Mike

PS: If it's any consolation, my head hurts, too. :(

PSS: Is Lotana going to have a crack at this one?

Les

07-10-2002, 11:18 PM

Hang in there, Lissy - it gets interesting (with thanks to Geoffw for the "out-of-the square" ideas....)

Shop D has no tenant - thus "hi-risk" - thus return should be 14% or better. i.e. offer no more than $183000. Given that my prospective tenant will move in within 6 months, paying $220/sqm, this re-values the shop at $319k at 8% - so $100k+ gain (less costs) on $55k (30% deposit). Of course, I need to pay a mortgage for 6 months of the year with no income (allow a further $10k for that - 8% interest). Still, $100k gain (equity) on $65k investment is not too shabby. Use JV, or vendor to put up some/all of the deposit? Wouldn't THAT be nice.

Interesting ideas that "popped up" while considering this (some of these are BOOMERS - thanks for posting this. Mike):-

1. The rate of return has NOTHING to do with the tenant - they are paying a standard $/sqm rate - your rate of return is SOLELY based on the purchase price!!! This is so important - as, if you buy well, add value (a tenant !!), then the equity jump is ENORMOUS.

2. Going on from the above, a change in $/sqm makes a minimal difference - so negotiating a deal to get your new tenant in by putting the $/sqm down somewhat makes little difference to them, or your income, but can make a huge difference to the VALUE of the property. e.g. the value jumped from $183k to $319k SIMPLY by putting in a long-term, low-risk tenant.

3. And going on from THERE, I'll post an alternative, geoffw inspired, out-of-the-square option.

To summarise this one, offer $183k. If I get it for this price, I'd be very happy. Depending on my findings after my NEXT post, (i.e. if the scenario didn't work out), I might come back to re-adjust this offer.

Les

08-10-2002, 12:18 AM

(Bring a packed lunch - this could become "War and Peace") ;)

Summary:-

Shop A:
74 sq m, Rent $16,000 ($216/sqm), franchisee, sold for $232000

Shop B:
102 sq m, Rent $23,000 ($225/sqm), baker, sold for $255000

Shop C:
140 sq m, Rent $32,000 ($228/sqm), Mr Dodgy, sold for $228500

Shop D:

To be sold at auction shortly
116 sq metres; Price: ?????????

Scenario #2:- (Line up the ducks ....)

1. Have coffee with Mr. Dodgy's landlord to see if he would be interested in selling Shop C. Sound him out - if interested, then...

2. Check whether my prospective tenant would like to occupy a larger premises (140 sqm rather than 116 sqm). Yes, then...

3. Visit Mr. Dodgy in shop C - check out his operation, and discuss whether his operation could operate in Shop D (with rental gain - to him - of around $100/week). Do I want him as a tenant? Will a rent decrease improve his operation enough to bring his "risk factor" down to (say) 11% ? Is he interested? Yes, then...

4. Shop C - returning 14% to dodgy landlord - nett gain to him after mortgage of $20k per year - offer $40k above his purchase price ($268500). Take option on Shop C for 9 months.

5. Back to retailer - get a "Letter of Intent" - with an "out" clause in case I can't buy Shop D - have him take Shop C in that instance.

5. Purchase Shop D at auction - up to purchase price of $200000

6. If unsuccessful at auction, I have 6 months to buy Shop C, move Mr. Dodgy on, and make ready for my retailer.

7. If SUCCESSFUL at auction, Dodgy moves into D within 3 months, and I arrange to buy Shop C for $268k. Dodgy's rent drops from $615/wk to $515/wk and is paying $230/sqm. A rental hiatus (6 weeks? or $3000) would help him to cover his moving his costs, and allow him to settle in. On assumption that his viability has increased to make the risk 11%, this revalues Shop D at $242k.

8. I buy Shop C for $268k, and it revalues at $385k after retailer moves in. Costs, of course, come off any gain.

There are a lot of ducks to line up in this scenario - and Murphy would undoubtably step in and muck things up somewhere along the line. So, in reality, the risk factor may be even greater than just buying Shop D (thus offered price at Auction, should maybe be LESS).

But, whatever, it was an interesting scenario to consider - let's see how the Auction goes!! :)

I'd also be very interested in forum comments re the above scenario (+ve or -ve, no probs).

Mike

08-10-2002, 12:43 AM

This post is a reply to Les' post #10. Unfortunately, Les got in too quickly and didn't see it before he posted #11.

Thanks Geoff and Les for having a go. Here is a summary of your views to date. (Trying to minimise any more sore heads)

Geoff:

Says quality of potential tenant for Shop D is similar to baker in Shop B, therefore, comparable yield is 9%

Les:

Says quality of potential tenant for Shop D is comparable to yield of 8% which is somewhere between the excellent National franchise tenant and the fair Baker tenant.

Although 1% difference might seem small it means that because the yield can't be manipulated by increasing the rent Les' estimation of the value of Shop D with a good quality tenant is going to be higher than Geoff's estimation. So if the tenant was already established in Shop D Les would be prepared to bid up to $319,000 whereas Geoff thought $283,500 was about right.

However, this is where it gets interesting. It seems Geoff is very confident that the tenant will fulfill the agreement and lease the shop within 6 months and so Geoff hasn't factored in any holding losses to discount the bid price with.

On the other hand, Les is saying the risk of buying the shop untenanted is comparable to the same yield as Shop C is getting with a dodgy tenant ie 14%. So the risk amounts to $135,000. Les is prepared to discount the tenanted value of $319,000 by a whopping 42.3% to get the bid figure of $183,000.

This is very interesting indeed because if Geoff has some kind of surety or legally binding agreement with the tenant that they must enter into a lease upon the successful purchase of the property, then Geoff will purchase the shop with his higher bid.

Les, may I suggest you and everyone else who may put in an offer base the offer on having secured the lease already with rent payments to start no later than 6 months after the property is purchased. I take your point that people who haven't secured a tenant prior to buying will not be in the race for Shop D when their offer will be so much lower than people with tenants lined up.

So, to level the playing field, somewhat, take it that you have secured the tenant. Now that is sorted out Les, are you going to offer $319,000 or will you still apply a discount?

You said you are prepared to discount the interest payments of $10,000 which brings the offer down to $309,000. Anything else?

Mike

AndrewC

08-10-2002, 03:30 AM

OK here goes nothin....

1. I assess potential rent on D at $26,300 pa (giving $226.7 per SqMtr). This is a linear interpolation between B and C using SqMtrs and Rentals. That is...

RentD = [(32000-23000)/(140-102)] * (116-102) + 23000

2. My rent prospect is a popular local business - same as the baker. If they could move in the day after the auction I would be prepared to pay $292,200 ($26,300/9%) for the premises.

3. If my tenant prospect is a certainty (this means no risk) to take up a lease in 6 months, I need to subtract 6 months holding costs (and add back any income from temporary use of the premises etc.) to come up with my final offer price -- so that in 6 months time I'm making 9% rental return on my total costs. Let's say interest, insurance, rates etc. comes to 7.5%pa on the purchase price. That means I subtract $20,400 to get my offer price of $271,800.

In 6 months time my circumstances will be exactly the same as the baker's landlord, except my place is 14% larger! (Baker's place is $255k * 114% = $290.7k for my joint --- interesting!)

The whole point I guess is to evaluate the transaction on a 'risk equivalent' basis. My offer price will beat anyone that factors in a longer vacancy period or higher risk tenant (or higher holding costs or indeed different "qualitative" factors such as passing traffic, parking etc.) ---- assuming I am satisfied with the 'market' return of 9%.

So Geoff would outbid me and I would walk away ---- thinking he had secured a national brand for a tenant. ;-)

regards, Andrew.

Mike

08-10-2002, 08:14 AM

Hi Les,

This is a reply to Post #11 which is your second offer.

Interesting plan but it seems flawed.

Point 5 suggests your intent is to purchase Shop D and install Good Retailer there. You say that if you don't get Shop D then the backup plan is to buy Shop C, boot Mr Dodgy out and put Good Retailer in there.

However, Point 7 suggests that, in the event you get Shop D, you want to move Good Retailer into Shop C anyway. In that case Mr Dodgy moves across to Shop D. Point 5 and 7 seem somewhat contradictory.

In any event, I think Mr Dodgy will not leave Shop C without Shop D to go to. How much will you pay him to leave a certain future for an uncertain future? If he doesn't go I assume you won't exercise the option on Shop C. Not only have you forfeited the option fee but you will leave Good Retailer high and dry without a shop. Therefore, you MUST buy Shop D. However, I think you will not get it if you limit your offer to $200,000. This figure is not much more than the untenanted value of the shop which you said was $183,000. If other bidders also have tenants lined up they will undoubtedly bid nearer the tenanted value.

Let's assume you have to bid $284,000 to beat Geoff's bid of $283,500. You won't be able to move Mr Dodgy into Shop D because the value will be reduced to $242,000 which leaves you in a negative equity situation and probably unable to secure a loan unless you came up with a sizable deposit. The deposit you require is $114,600 because a 70% loan on $242,000 is $169,400.

You need a further $80,550 deposit to buy Shop C. Total cash outlay is $114,600 + $80,550 = $195,150. However, equity gain on Shop C is $117,000 which still leaves $78,150 tied up in the deal. Compare this with a deposit of $85,200 to just buy Shop D and a possible revalue to $319,000 with Good Retailer as tenant and your net cash in the deal is only $50,200. So, the bottom line is that if you can get Shop D for under $242,000 then also buy Shop C but if the bidding goes above $242,000 then only buy Shop D and put Good Retailer into it.

Regards, Mike

Les

08-10-2002, 08:23 AM

"On the other hand, Les is saying the risk of buying the shop untenanted is comparable to the same yield as Shop C is getting with a dodgy tenant ie 14%. So the risk amounts to $135,000. Les is prepared to discount the tenanted value of $319,000 by a whopping 42.3% to get the bid figure of $183,000."

G'day Mike,

I guess what I'm looking at here is the relative perspectives of buyer and seller. As in my Dolf de Roos story, if a seller has no tenant in place, then the risk to be the buyer is obviously going to be higher than with a good quality tenant in place. So, the seller will have to sell at a discount.

The buyer then assumes the risk of finding a tenant (if he already has one signed up, this does NOT imply that he should share the knowledge with the seller - or the profit). So the buyer stand to make a nice profit.

Then, again, if the buyer is needing to bid against others who have the same advantages he does (e.g. this topic), then he maybe needs to lift his offer to "beat the others", or go running of to find another deal where the number of buyers are less. The seller does better than he perhaps should in the current scenario.

One other thought is this:- Is an empty shop of LESS value than a dodgy tenant? By having it empty, there would be no dramas with tenants vacating, access for inspections are no problem, and timelines for new tenant are unlimited. So, by valuing the empty shop as equivalent to a dodgy tenant, I might be mis-reading the situation......

As you said earlier, Mike, this one is certainly not just a "mathematical puzzle" - there are a truckload of variables to consider.

Decision time:- :(

Anyway, without re-typing a bunch of stuff, I'm gonna bid at auction up to $210000. If I miss that, I will recheck with my retailer to see whether his needs have been suited by another landlord (the SUCCESSFUL bidder for Shop D, perhaps?) If retailer is still looking, I have maybe 3 months to negotiate with owner of Shop C to take over his interest, throw out Mr. Dodgy, and put my retailer into Shop C (all the while mumbling about "emotional" bidders at auctions that cause all this extra work for me ;) )

With Shop C, I can buy for up to $285k (if the current landlord is hard-nosed, wanting three years profit upfront) and still gain near $100k in equity once my retailer is safely ensconced therein.

Failing all that, I go find another group of shops and try to keep well clear of that Somers mob who bid too high at auctions !!!

A few clarifications:-
I've tended to value the retailer as being less of a risk than a baker. Major reason is because he has 12 shops already, so is obviously very successful at what he does. The baker, on the other hand, is a "one man band" with all eggs in one basket. Not necessarily bad, but slightly more risk than the retailer, IMO.

Mike> "So if the tenant was already established in Shop D Les would be prepared to bid up to $319,000 whereas Geoff thought $283,500 was about right."

Les> Not this vertically challenged, pigmentally differentiated, seasonally endangered waterfowl !!! (little, black duck!! ;)) I'm not wanting to pay "market price" If I've found the tenant, I want the reward for doing so. So I'm certainly not going to give the seller the profit for doing what he should have done (i.e. find a tenant).

True, though - my offer could lift somewhat and I would still make a nice profit..... I'll be at the auction, but keep my hand down and just watch the fireworks. If things stall at any time prior to (say) $250k, I might be tempted to come in at that figure as a final bid. So, change my bid on that basis, Mike.

In closing, I like that first "boomer" thought that struck me (posted a little while back) - it was worth doing this exercise just to have that thought hit home!!

The rate of return has NOTHING to do with the tenant - they are paying a standard $/sqm rate - your rate of return is SOLELY based on the purchase price!!! This is so important - as, if you buy well, add value (a tenant !!), then the equity jump is ENORMOUS.

Another thought-provoker, Mike - thanks !!!

AndrewC

08-10-2002, 09:15 AM

I made a slight arithmetic error at step 3.
The deduction should have been $10,560 (only a half year of holding costs) making my final offer price $281,640.

cheers.

Mike

08-10-2002, 02:22 PM

Hi Folks,

Thanks everyone for your bids so far. The discussion has been most illuminating. Please get your final bids in by 9pm EAST because I'd like to post the answer and some final thoughts.

Mike

Ross Sneddon

08-10-2002, 04:16 PM

Hi

A good thread, I like the concept of discussion.

Some NON mathematical leasing comments first.

Shop A is let for $216 psmpa (per square metre per annum) to a National Franchisee. These types of lessees typical screw the owner down to the lowest rent possible which is evidenced by the return on investment of 6.8%. Owner loses.

Shop B is let for $225 psmpa and yields 9.0% to a popular local baker and this seems OK to me.. Win / win situation.

Shop C is let for $228 psmpa and yields 14% to an unknown tenant of doubtful quality. From here we are now refering to him as "dodgy" - why? There is no suggestion of not paying rent, of being a bad tenant in any way and premises are said to be in similar condition to the other shops. I suggest to you that a yield of 14% for a shop is high. Owner rip off, win / lose situation.

Shop D To be determined

There is a formula used by Valuers in determining the rental value of premises which is complex but it essentially says that the rate per square metre depreciates for each metre you retreat from the shop front towards the rear of the shop and from the sides towards the centre. In other words the square metres at the front centre are the most expensive to rent and the back corners, the cheapest.

Larger premises are therefore cheaper than small kiosk type premises psmpa. Let's not get too involved.

Now the rent is also influenced by the quality of the current tenant, length of lease, position, passing traffic and all those many other good things that have been raised by others before me in this thread. I won't continue.

I do not consider a tenant "good" if we have to wait six months for them to take up occupancy. Apart from the loss of rent, there is a degrading effect on the other tenants and on the shopping centre (or strip etc) as a whole. No one wants empty tenancies.

If the tenant is considered "potentially good", then offer moving costs, break costs with current tenancy, a rent free period which is picked up later in the tenancy, assistance with fitout, maybe other features which can then be built in to the overall rental return which can be financially beneficial to the owner in the longer term. But above all KISS.

The sale value of the shop is now almost exclusively based on rent return as variations have been taken into consideration in the rent determination.

So lets strike a figure. The baker seems to me to be the one paying the "most likely" rent at $225 psmpa. So $225 X 116 M2 calculates to $26,100

For ease, $26,000 at 10% pa return gives a sale value of $260,000, at 9% the sale value is $289,000 and at 11% the sale value is $236,000.

My feeling is towards the 9%, so offer say $280,000 and be prepared to come up a bit.

But don't get too involved in mathmatics. It doesn't follow the same patterns as it does in Residential Real Estate.

Regards

Ross

Ross Sneddon

08-10-2002, 04:48 PM

Hi

I have been reading back over some of the other contributions to this thread and I find it a little disconcerting to see so much arithmetic in arriving at an answer. It should not be necessary.

If you buy the premises at auction, it would be great to have a tenant lined up to move in, however, if you don't have one, it will only alter the sale value marginally in your eyes but not necessarily at all in the eyes of other bidders. Look ahead, and you could find yourself in a similar position of no tenant in a year or two. There is a greater risk in commercial investments, and that is why you receive a greater yield.

Some people have decided to solve some of the problem by evicting the lessee in shop C. We are talking about leases, not tenancies, which in most states of Oz offer the lessee a considerable amount of security, perhaps more so than a tenant in a tenancy (residential).

If you wish to evict this lessee, be prepared to have to pay the lessee a LARGE slice of dollars, perhaps an amount equal to the remainder rent of the lease agreement. Now if the lessee has paid for an expensive shopfront, installation of equipment, fixtures and fittings, advertising etc., he will want compensation and you could be up for big bickies. It could be very unproductive, unless of course he breaks the lease agreement.

If it goes to Court, it is not a tenancy tribunal BUT full on Court process and that can be expensive, wigs and gowns and all that.

Think before you try and tip the lessee out.

Regards

Ross

Jakk

08-10-2002, 10:22 PM

G'Day all,

I wrote out a real Hans Christian Anderson last night in reply to this thread but now that I have checked....tis not there!

So as I need to get my bid in now, I will just put the figures up.

Shop is a vacant shop and therefore quality of any future tenant that is not currntly signed up, I will disregard.

Expected or anticipated rental return $25,000 - $26,500 based on comparable rentals.

As the shop is being sold vacant, there is a high risk factor here, possibly slightly higher than a shop being sold with a "Dodgy Tenant"

therefore I would be looking to buy at a price that would achieve a return of the "dodgy Tenant shop" at the very least.

Therefore my offer based on a possible return of around 14% would be in the region of $189,000, lets say $190,000 tops.

If I manage to secure a tenant, then that would be achieved through my efforts and as sure as hell I would not be paying the present owner for something that I had done.

So thats it $190,000, take it or leave it, otherwise watch me walk.

regards

Mike

08-10-2002, 11:11 PM

Hi Folks,

Well, the time has come to wind this great thread up. Thanks to everyone who participated, especially GeoffW for putting in the first offer. It got the discussion moving and led to many interesting points. I've learned a lot from both Part 1 & 2 and will share some of those thoughts, later.

I wish I could credit myself for creating those exercises but I'm not that clever. The exercises were lifted from a book I recently acquired from attending a property investment show. I saw it displayed with the title Buying Bargains at Property Auctions by Howard R Goodie. Well, with a title like that how could you not pick it up. I read the back cover first and learned that the author was an experienced property auctioneer. Well, since most books in my collection seem to be written by investment gurus, solicitors or accountants I thought a book by an auctioneer would be different to anything I had. I quickly scanned the contents and some of the chapters and in only a few seconds I realized there was a bunch of information in the book which I had never come across before. An insider's view of the auctioneer's trade. Very useful, I thought, to know how the auction is being manipulated.

Example: Advice to a Vendor

Do not bid yourself unless agreed beforehand with the auctioneer. The auctioneer will wish to judge if it is necessary to make bids on your behalf to maintain the momentum and rhythm of the bidding.

Do not wait to fix the reserve until the last minute. Auctioneers need to have their documentation and strategies prepared well in advance.

Do not change your mind about the reserve price. Remember, if the bidding does not go well the auctioneer will make bids on your behalf.

How the auctioneer bids the price up - in practice

(the auctioneer has a reserve of £45,000):

AUCTIONEER: On behalf of the auctioneers, I give notice that they reserve the right to bid, through me or otherwise on behalf of purchasers who have left bids with them, or on behalf of vendors, or as agents, or as principals for any lots.

AUCTIONEER: I now wish to offer lot number one, a charming and desirable residence with vacant possession at 10 West Road, Lewisham. Where may I start the bidding? £50,000? (Silence)

AUCTIONEER: Well, ladies and gentlemen, it is in your hands and not mine as to where we start the bidding. Should it be £45,000? (Silence)

AUCTIONEER: Will £35,000 tempt someone to bid? Thank you, sir, I have your bid (as bidder number one waves his catalogue vigorously in the air).

AUCTIONEER: I am bid £35,000. Do I see £37,500? £37,500 anywhere? (No one moves in the room.)

AUCTIONEER: £37,500 I am bid.

Note: This is a bid which the auctioneer has interjected on behalf of the seller. The bidding level is well below the reserve of the lot but the auctioneer wishes to keep the momentum of the bidding going and has seen no signs of anyone else wanting to bid in the room and has therefore exercised his right to bid on behalf of the owner.

AUCTIONEER: £40,000 anywhere? (Bidder number one nods his head discreetly) [Mike: Bidder 1 has been sucked in by a dummy bid to lift his bid by £2,500.]

AUCTIONEER: £42,500? (No one moves in the room.)

AUCTIONEER: I am bid £42,500.

Note: This is the second bid that the auctioneer has made on behalf of the seller because there is still no momentum in the bidding and the reserve has not been reached.

BIDDER NUMBER TWO: £45,000.

AUCTIONEER: £45,000 I am bid. £47,500 may I say? (Bidder number one nods his head.)

AUCTIONEER: £50,000? (Bidder number three winks)

AUCTIONEER: £50,000, I have your bid sir. £52,500 anywhere? Any further bid? I am bid £50,000. I am looking for £52,000. Are you all done, has the bidding finished? I am bid £50,000 for the first time, for the second time.

Note: The auctioneer is now above his reserve. He cannot take a further bid on behalf of the owner/seller and is therefore about to bring his gavel down if there are no other bids from people in the room.

AUCTIONEER: Sold at £50,000 (looking at the successful bidder pointedly). May I see your paddle number, sir? (Bidder number three shows his paddle number as 142.)

AUCTIONEER: Sold to 142 at £50,000 and for my next lot....

------------------------------------------------------------------------------------------------------------

If anyone is interested in the book it can be ordered through Amazon.co.uk. Bear in mind that it is written for the UK but it is chock-full of interesting info so you should find a lot of it useful. I know this post has been off-topic but I thought you wouldn't mind. My next post will address the exercise.

http://www.amazon.co.uk/exec/obidos/ASIN/1902646681/qid=1034051506/sr=1-1/ref=sr_1_2_1/026-3298226-0149233

One customer review said this:

An interesting guide which takes some of the mystery out of the world of property auctions.

Whether you are looking to buy a new home for yourself, or purchase property to develop/let, this book clearly illustrates the pros and cons of buying at auction. It assumes no previous knowledge of the subject and presents a clear step by step guide to what happens both before and after the auction.

The author is clearly well versed in the world of auctioneering. He does an excellent job of explaining the auction process and exposes tactics used by auctioneers and bidding strategies.

Les

09-10-2002, 12:02 AM

G'day Ross,

Ross has said>> "Shop A is let for $216 psmpa (per square metre per annum) to a National Franchisee. These types of lessees typical screw the owner down to the lowest rent possible which is evidenced by the return on investment of 6.8%. Owner loses.

Shop B is let for $225 psmpa and yields 9.0% to a popular local baker and this seems OK to me.. Win / win situation.

Shop C is let for $228 psmpa and yields 14% to an unknown tenant of doubtful quality. From here we are now refering to him as "dodgy" - why? There is no suggestion of not paying rent, of being a bad tenant in any way and premises are said to be in similar condition to the other shops. I suggest to you that a yield of 14% for a shop is high. Owner rip off, win / lose situation.

Shop D To be determined

Les>> I note your comment re franchisees that screw down rents, etc. I admit that thought had crossed my mind. The baker was a "win/win" - can we say average deal? Then, my mate mr dodgy and his operation, you have defined as "win/lose".

But, is this really so? If so, WHO is winning/losing? Since these were all sold within the last month, there can be no "held it for 15 years" situations, so the 6.9%, 9%, and 14% HAD to be reflections of how BUYERS saw the 3 situations, doesn't it??

a. I can understand buyers getting excited about a National franchisee, and perhaps OVERPAYING to buy. This buys them a silhouette of security, at the expense of their cashflow, and their capital gains, yes?

b. Seems to be a "middle of the road" type of deal - probably the "truest" of the 3 ? Return 9%, - you described as win/win.

c. the "Mr Dodgy" place - 14% return - but, since he is paying $3/sqm more than the baker, is it really "ripping him off"? Or is he simply paying a slightly higher $/sqm because he has been able to rent a larger shop? Let's face it, he is paying 1%+ more than the baker. A rip-off? Nah, I doubt it.

BUT, if there is a small pool of buyers, WHO would THEY want as their tenants? A National franchisee (Retravision?), Mr. Bun the Baker, or a vague identity with a doubtful business?

The way I see it, Ross, it is the buyers that dictate the %age rental return with "the price they are prepared to pay". My mate in Shop C is really not getting "ripped off", but the seller possibly paid a price for not having sourced a "more reputable" tenant.

Your reply overall showed me you have more knowledge in this area than I do (I have residential property only) - but I've enjoyed "stretching" to have a crack at doing a cyber deal. I'd be interested in your comments re my points above. Am I missing something? Out in left field? Or am I making sense? Or all of the above?? ;)

I look forward to your further comments,

Regards,

Mike

09-10-2002, 01:24 AM

To summarise the bids:

GeoffW

Rent: $25,520 pa.
Yield: 9% (Same as baker)
Tenanted value: $283,500.
Discounts: None
Final Bid: $283,500.

Les

Rent: $25,520 pa.
Yield: 8% (Rates tenant better than baker)
Tenanted value: $319,000
Discounts: $10,000 (6 months interest); $59,000 (Risk for sale without lease)
Final Bid: $250,000.

AndrewC

Rent: $$26,300 pa.
Yield: 9% (Same as baker)
Tenanted value: $292,200.
Discounts: $10,560 (6 months holding costs)
Final Bid: $281,640.

Ross Sneddon

Rent: $26,100.
Yield: 9%+
Tenanted value: $283,500.
Discounts: ('sale without lease' risk is factored into the yield)
Final Bid: $280,000.

Jakk

Rent: $26,500 pa.
Yield: 14% (Same as Dodgy Tenant)
Tenanted value: $283,500.
Discounts: ('sale without lease' risk is factored into the yield)
Final Bid: $190,000.

Book Answer (The $ figures are slightly different to the book because the book uses sq ft instead of sq metres)

Rent: $26,065 pa.
Yield: 8% (Between franchisee & baker)
Tenanted value: $325,800.
Discounts: $13,000 (6 months rent); $10,000 (Costs/interest 6 month); $22,800 ('sale without lease' risk)
Net Value: $280,000. ($325,800 - total discounts $45,800)

Note: the rent was calculated by working out the rent per sq metre for each shop, then averaging the three figures. The average came to $224.7 per sq m. The annual rent for Shop D then is 116 X 224.7 = 26,065.

List of bids in ascending order with the highest bid on top:

GeoffW: $283,500.
AndrewC: $281,640.
Ross Sneddon: $280,000.
ANSWER: $280,000.
Les: $250,000.
Jakk: $190,000.

Well, Ross nailed it but Geoff got the shop. Congratulations fellas. However, once the euphoria is over and we examine how the respective bids were arrived at we see that Geoff got the prize without paying too much over true value by PURE CHANCE rather than design. Sorry, to crticize here but it's post-mortem time. What can we learn? Isn't it ironic that Geoff didn't get the yield right and didn't offer a discount but still bagged the prize at a reasonable price. Reason is his yield of 9% turns out to have enough risk discount built-in that he didn't need to factor in lost rent or interest.

What about Ross who nailed it? Well, again Ross factored the 'sale without lease' risk into the yield and came up with a figure of just above 9%. It seems Ross, Geoff and Andrew were not prepared to slash the Shop value down to near the unleased value because of their confidence that they had secured a good quality tenant. According to the book figures, the total discount or risk amounted to 14% of the leased value.

Les and Jakk, on the other hand valued the shop without a lease first. They both rated this as equivalent to a yield of 14+%. Jakk didn't factor any gain whatsoever in the fact that he had secured a good tenant because he didn't think the vendor should profit from his efforts to secure that good tenant. Les also doesn't think the seller should profit for the same reason but is willing to be flexible up to $250,000 knowing the other bidders may have good tenants also lined up and will bid up accordingly.

I have a few other thoughts about what I have learned in this excellent thread but I will post them later.

Regards, Mike

PS: Congrats to Les for correctly determining the quality of the tenant (with lease) at 8%.

Mike

09-10-2002, 09:45 AM

Further thoughts...

The biggest difficulty everyone had in that exercise was estimating the risk of buying the shop without a lessee even though a good tenant was lined up. The exercise would have been simplified if Shop D was being sold with the Good Tenant already under lease. It would just be a matter of determining the quality of the tenant in terms of rental yield and calculating the value from that.

A little harder would have been to estimate the value of the Shop with no tenant lined up. Les and Jakk thought that the yield comparison was 14+%. To be frank, I have no idea why or how they arrived at this figure except that it seemed right to compare a vacant shop with a leased shop with a dodgy tenant. How good was this comparison?

If I were to ask, "If I bought this vacant shop, could I find a good tenant and how long would it take me to find this good quality tenant? Let's say that you figured you could find a tenant of similar quality to the baker (9%) within 6 months. Then the figure you could bid up to is $269,000 [$290,000 - (6 months rent and interest)]. If you wanted a local chain retailer (8%) which could take a year to secure then you could bid up to $280,000 ($326,000 - $46,000). If you wanted a very good tenant (6.9%) and was prepared to wait 18 months or offer equivalent cash or other incentives to secure them sooner, then the figure you could bid up to is $308,000 ($378,000 - $70,000).

All these scenarios represent you bidding up to the leased value minus the discounts of lost rent and holding costs. However, let's say that you won the auction with a bid of $308,000 but could only line up a wine merchant after 18 months with a yield rating of 9%. What is your loss? $65,000 interest plus rent and lost value of $88,000 ($378,000-$290,000). Total loss is $153,000. That is your maximum risk amount to buy an unleased shop.

So, therefore, Shop D without a good tenant is valued at $326,000 - $153,000 = $173,000. That's $10,000 less than Les' estimation of $183,000. So it seems Les and Jakk were pretty close with their estimation of unleased value.

Now, why should we pay the vendor $100,000+ extra for a vacant shop? Firstly we have a good quality tenant lined up and the pressure is on to get them a shop. We are prepared to wear a 6 month vacancy and even if the good tenant took a runner we could quickly get a dodgy tenant in short term paying 14%. The rent per sq metre per annum is the same but where we lose on the swings (lower value) we gain on the roundabout (positive cashflow). We bide our time until the right tenant comes along. At least we got the shop and we are in the game. I think that is why $280,000 was a realistic bid figure.

Mike

Jakk

09-10-2002, 11:12 AM

Ahhh Mike,

Alright, you are a good salesman and you,ve convinced me, I'll go to $200,000 but there's no more in it, that,s it.

Now if the Vendor won't accept that, I'm walking.........look I'm at the door now.........if he doesn't take it I'm gone.........look!!!!!......opening the door now.

regards

JoannaK

09-10-2002, 01:03 PM

absolutely fantastic thread folks!!!

geoffw

09-10-2002, 01:21 PM

I agree Joanna. I got slam-dunked :D but learnt a lot.

Ross Sneddon

09-10-2002, 03:26 PM

Hi Les and All

I think that the concept of these exercises is great and welcome more.

To answer Les's questions.

I noted that the three shops all sold recently but admit I let that fact slide past me as time went by. My uncertainty is I don't know if the shops were leased prior to or after auction and sale a month ago.

Shop A If this shop was purchased first and then rented, I can see a situation where the lessee argued for a low rental, the owner saw a strong sound lessee (National Franchisee) and agreed to a modest rental yield. 6.9% which is not much better than residential (in QLD)

If purchased with lessee in place, then the owner has perhaps bid a little more than he otherwise may have, so he earns a modest income. But that is the bidders perogative on the day. I initially described this as a lose / win situation BUT if the purchaser is satisfied then win / win.

Shop B I agree Les, this seems to me to be the "middle of the road" scene. A good well liked Baker, a good tenant, a return on investment of 9% and I guess increasing with rental increases over time. Once again a win / win for both parties.

Need we say much more. I agree Les, an average deal.

Shop C The original description is "tenant is unknown and of doubtful quality". In my earlier comment I said that this was no reason to call him Mr Dodgy. My apologies to GeoffW. You were the first to bravely put your foot in the water and name him and I don't wish to be critical. You may prove to be correct. We were the cowards.

My point is that although he is unknown and doubtful, he may turn out to be a good tenant. Let's not tar and feather him - yet!

This shop is about 1/3 larger than the Baker in shop B. In my earlier comment yesterday I briefly mentioned the valuation technique of estimating the value per square metre of a premise. Therefore the overall rate per metre should be lower than Shop B

On this basis, the larger Shop C should reflect a greater differential with Shop B than the $3 psmpa that you pointed out, and the return of 14% is a little high. Great if you are the lessor but maybe in the long run, it could come back and bite you on the bum.

Now if the lease was in place at the time of the auction, we could argue that the purchaser bought well, even below "true valuation" whatever that is. My feeling is it is a bit of each. A truer valuation may be a valuation of around $2,000 psm for a purchase price of $288,000 and therefore a rental yield of 11%. This would be closer.

This means that the purchaser was canny and did very well. OK I'll take back the "owner rip off" bit, but the rent is still too high.

I agree that the other purchasers would prefer a "quality tenant" but we can't all have them. Mike indicated that the shops were on a street so are of a more diverse mix. In a large shopping mall like Westfield or Stocklands etc., you do find an excessive number of the franchised or chain stores. That's great but many people comment that they don't want this and that this is boring and don't like shopping in Malls. We would expect to find in this diverse mix of strip shopping, some "unknown and doubtful tenants".

Once again, if the shops were leased prior to sale, then the purchasers dictated the rental returns by their purchase price but if the shops were leased after sale, then it could be a bit of each.

Now that I have argued for a different set of values, it means that my sale price bid of $280,000 and prepared to go up a bit is blown out of the water. Maybe I should take it all back.

The other part I only briefly touched on yesterday is the "six months wait " for the new tenant. Mike put this in the exercise OK but I cannot agree that it is acceptable. As an owner, you would do all in your power to get the tenant in place as soon as possible. You cannot wait the six months, invoking the ire of the other owners and tenants nearby and degrading the value of the Shop D by being empty. Even in the eyes of the shoppers, it would become a shop with a problem even when opened in six months time.

The owner should sacrifice some dollars to have it tenanted and make up some, but perhaps not all, of the loss in the rent over the coming months. The longer the empty timespan, the more to be made up from somewhere and the less profitable is the venture. Enough said.

Les, I am open to any further comment you may have.

A good exercise. Mike let's have another sometime.

Regards

Ross

AndrewC

09-10-2002, 03:47 PM

Hi Ross

You say in the real world -- shop rent psm should increase as the shop size reduces, all other things being equal. And I guess for very large shops the rent psm will level out such that it remains about the same as floor area increases further.

Is there any "real world" rule of thumb for this!?

Like your comments on valuation by the way!

Andrew.

AndrewC

09-10-2002, 04:11 PM

PS. Where does one actually get information on lease rates for commercial/industrial properties to do a comparison? Or do you just have to ask around.

Les

09-10-2002, 10:21 PM

G'day Mike,

You said "Now, why should we pay the vendor $100,000+ extra for a vacant shop? Firstly we have a good quality tenant lined up and the pressure is on to get them a shop."
Les>> OK !!

Mike>> "We are prepared to wear a 6 month vacancy and even if the good tenant took a runner we could quickly get a dodgy tenant in short term paying 14%."
Les>> I don't think so, Mike - AFTER BUYING, tell me what $/sqm a "dodgy tenant, short term" would have to pay to give you 14% ??? Sounds to me like around $400/sqm - without jumping for the calculator.

As I noted earlier (in a real BFO) the 14% return comes from BUYING AT A DISCOUNT. The likelihood of getting 14% AFTER buying at an 8% valuation is right up there with pushing the proverbial uphill with a chopstick.

Mike>> The rent per sq metre per annum is the same but where we lose on the swings (lower value) we gain on the roundabout (positive cashflow).
Les>> Huh ?? HUH???? Do you STILL think the same way after reading my previous paragraph, Mike? If you do, I seriously need some teaching here - I don't see this making sense at all.

Mike>> We bide our time until the right tenant comes along. At least we got the shop and we are in the game. I think that is why $280,000 was a realistic bid figure."
Les>> And I still think you overpaid ;) But the vendor probably made things better with that case of champagne, what??

Interested in your further thoughts, Mike.

Regards,

Les

09-10-2002, 10:55 PM

G'day Ross,

Your comments below, and my responses:-

Ross>> "Ignore the entry above. Something went wrong."
Les>> The TAB has done this over 3 forum types. The FIRST TAB seems to drop you out of the reply screen. If you use your cursor and left-click back IN the reply, you can continue on. The second TAB (?) or Enter completes the post, and there it is !!!

However, you can "re-edit" your own posts on this forum style too (as you could with the "old" one. So, you didn't have to start over - and probably won't next time.

Ross>> "I still think that the concept of these exercises is great and welcome more."
Les>> Ain't it great - Mike has a BOOK FULL of them :D

Ross>> "Therefore the overall rate per metre should be lower than Shop B. On this basis, the larger Shop C should reflect a greater differential with Shop B than the $3 psmpa that you pointed out, and the return of 14% is a little high."
Les>> OK - I think what I'm hearing here is that the $/sqm for Shop C should be LESS than Shop B - would that be as low as Shop A (which is smaller again, but the NatFran screwed down the rental). So, Ross, any considered opinion on a realistic $/sqm for Shop C? Should it be $5/sqm cheaper, $15, or $25??

I have no idea whatsoever on this. A further thought, Shop B should also be nearer Shop A (it is also larger than A, yes??)

Ross>> "A truer valuation may be a valuation of around $2,000 psm for a purchase price ..."
Les>> Is this my answer to the previous question (perhaps with an excess of zeroes ;)) Do you mean $200/sqm? (which answers the previous question wrt Shop A).

Ross>> "..the owner saw a strong sound lessee (National Franchisee) and agreed to a modest rental yield. 6.9% which is not much better than residential (in QLD)"
Les>> To assist others who are still getting their feet wet, it's probably a good time to point out that there are MAJOR differences between the expenses relating to commercial and residential property. e.g. tenant pays fitout, rates (?), etc. Ross, this is not in my area of expertise - can you expand a little on the differences. What struck me was "6.9% is not equal to 6.9% when comparing residential and commercial IP's" - am I correct? Any ideas, formulae, etc that would show an "average" difference factor? (example - "In general, commercial property yield of 6.9% is roughly equivalent to 9% - 10% if investing in residential property" - could you formulate such a statement, Ross?)

Regards

Mike

10-10-2002, 02:51 AM

Final thoughts...

Les>> Ain't it great - Mike has a BOOK FULL of them.

Sorry, folks, they are the only two examples in the book referred to in post #21. They were included in a chapter called "How to find your bargain property". The author was making the point that knowing the approx true value of a property means you can set your top bid according to your buying strategy. If you are after a bargain then you simply bid up to a discounted price, say 20% under true value and if you go to enough auctions you'll eventually get one. Determining the true value requires getting comparables and working out the comparable value of the target property.

Half the book is full of bidding advice, bidding examples and tricks that auctioneers use. A real eye-opener.

The author makes a number of comments regarding valuations. Here's one:

"The second greatest ability needed for an auctioneer is to be an accurate valuer. But with all the skill in the world it is impossible to judge what is in the mind of bidders on sale day. On that day, the cliche that valuation is an art not a science is put to the test. The auctioneer/valuer has all his skills, training and experience behind him. The auction house has access to to all the records of prices obtained for comparable properties, but in the end the judgement of value is still very subjective. Even the most competent auctioneer/valuer can find her confidence severely dented in the sale room. Especially, when lots that she advises may only just reach their reserve, either go on to sell at high prices after runaway competitive bidding, or have to be withdrawn at bids considerably less than she recommended as a value or reserve."

Mike: A UK forum poster recently gave this sage advice: Property deals are like buses remember-miss one catch the next one.

That's right, there's all sorts of buyer motives that you compete with at an auction or buying privately. I would describe it as, "Shaking a fruit tree until a piece of fruit falls to the ground.

Recently, I came across a downloadable 6.5 minute audio file of an interview with Neil Jenman where he talks about the 'Fed-up purchase' where people have often missed out on their dream purchase and bought something to live in which they are unhappy with. Again, another type of buyer who may outbid you on a property. If you are after value there is no sense in competing with them. They will keep bidding just to get it and end the hassle of looking at more properties. Jenman relates an example of a man who bought a home on three occasions by simply writing little notes and putting them in letter boxes of his target area and always had someone contact him with a property for sale. He never bought through a RE agent. The audio file is at http://www.abc.net.au/perth/stories/s506951.htm

Quote from Les - post #32

Mike>> "We are prepared to wear a 6 month vacancy and even if the good tenant took a runner we could quickly get a dodgy tenant in short term paying 14%."
Les>> I don't think so, Mike - AFTER BUYING, tell me what $/sqm a "dodgy tenant, short term" would have to pay to give you 14% ??? Sounds to me like around $400/sqm - without jumping for the calculator.

Good pickup, Les. Delete the last 4 words. Now it should read: "We are prepared to wear a 6 month vacancy and even if the good tenant took a runner we could quickly get a dodgy tenant in." Of course, they will pay the same rent as any other tenant. So, the cashflow position is no better. So you would rightfully be unhappy to have them devalue your shop. That is a risk, for sure. However, in one of your earlier posts you cited the example of Dolf de Roos.

Quote by Les in post #15

As in my Dolf de Roos story, if a seller has no tenant in place, then the risk to be the buyer is obviously going to be higher than with a good quality tenant in place. So, the seller will have to sell at a discount.

The buyer then assumes the risk of finding a tenant (if he already has one signed up, this does NOT imply that he should share the knowledge with the seller - or the profit). So the buyer stand to make a nice profit.

Then, again, if the buyer is needing to bid against others who have the same advantages he does (e.g. this topic), then he maybe needs to lift his offer to "beat the others", or go running of to find another deal where the number of buyers are less. The seller does better than he perhaps should in the current scenario.

It seems to me that Dolf was fortunate that no other bidders had tenants lined up. If they had perhaps Dolf would not have got such a bargain. Les, your strategy was to get the Shop at a big discount despite the risk of losing out and having to explain to a good tenant why you didn't try harder to get the shop. The others, however, wanted to get a good tenant who would add value to the shop. Each to their own. You may catch the next bus. ;)

Another point I'd like to make concerns estimating true value on a new construction. When I bought my Brisbane property in April last year I asked the marketing guy how they determined the sale price? He said they get 3 independent rent valuations from local RE agents and average them out. Then using the local historical yield, work out the true value of the property. Obviously, they must negotiate with the developer to buy the property at a price which leaves them with their marketing fee. If you buy off-the-plan directly from the developer knowing what the retail value of the finished product is you should be able to negotiate a good discount. I bought a Sydney property off-the-plan through a marketing company so paid for their fee in my purchase price.

Lastly, I think the safest way to buy property is to buy something and add value. That way, you will ensure that the improved value will make up for any minor overbidding. My brother-in-law, who is a builder and built his home, recently completed a renovation in his spare time. Took 8 months of weekend work. Bought a place for $130,000, spent $50,000 and will sell for $220,000. Profit $40,000. Net profit after CGT is $20,000 minus interest. Cash-on-cash return is approx 40% in 8 months. See you over at the Adding Value forum. :)

Regards, Mike

Ross Sneddon

10-10-2002, 10:30 AM

Hi Andrew C

To answer your questions

My comments about Rental Valuations are generalisations. There are always exceptions.

Some retailers must have huge floor space, like furniture stores, supermarkets etc., others who retail small items like sunglasses or Loto tickets only require a small kiosk of several square metres and can pay exhorbitant rates per square metre.

In a shop, the square metres at the front of the store are the most valuable and conversely, those at the back are worth less. It is obvious, and I'm not trying to be smart, but a shop puts its display at the front door not down the rear.

For very large stores, like a retail Garden centre or builders supply outlets they need to establish in Industrial areas where the land component is cheap and dictates retail costs.

Rule of thumb. Very hard. Each shopping centre, Mall or Strip has a certain turnover of traffic, vehicle and pedestrian and this will dictate to some degree the likely dollar turnover of the shops in that area. Large shopping malls run by companies which own or control the total centre aim to make their centre the biggest and the best. We may all have different ideas about that.

Lets assume they have built a centre which contains 100 shops, they interview maybe 500 prospective tenants and "sell" the same story about how good their centre is going to be. After a few dozen repeats of the same story of how good they are, they believe their own hype and bull **** and bingo, up goes the rental rate per square metre. No rule of thumb, just rule of I'm bigger than you and if you want in, you will pay.

Where do you get the info. It isn't as freely available in commercial as in residential real estate. In residential, Agents talk to each other, they see advertising in the papers, front of Agency shops, and they ask tenants.

In many large shopping centre leases, there is a clause prohibiting the disclosure of rental rates and the large centre Landlords use this to play one tenant off against the next.

To free up this information, some States require these leases to be registered with the Government authority or they are not valid. But there is no time limit and often years will pass before a lease is registered, and then only because it suits both parties to register the contract, or it suits the Landlord or there is a Court case pending.

Imagine a major retailer. Woolies, Coles, DJ's, GB's et al. A shopping centre needs a couple of them to "anchor" a shopping centre so will rent to them at dirt cheap rates, even for a year or so for free, just to get them. The cost of the construction of the shopping centre is still the same and the centre wants to make its 15% plus return on investment, so the smaller stores must pay an increase in rent to cover for the rent NOT paid by the major retailers. Little retailers are told that this is necessary because the large retailer draws traffic for the little one. You make up your own mind.

Shopping centres try all manner of tricks to overcome rental disclosures of anchor tenants. They may even charge a "regular rental rate" and then pay hundreds of thousands of dollars to the anchor tenant for fitout. Rent is disclosed, kick backs are not, the law is satisfied.

Andrew, little fellows like us just have to recognise that we are not in the same league as the big centres. We just need to ask around, keep our ears open and do our sums carefully. If we own the shop and are trying to determine a rental rate, then take the valuation and see if 10% looks to be a reasonable rate for an annual rent. Now add or subtract other features we have discussed here in this thread and vary the dollars up or down on the 10% yield.

When buying, the same thing applies. You will know how much the current tenant is paying, talk to them, they will all winge about the rent but will really howl if it is crippling them. Be prepared to give a little and don't be too greedy.

I can now see some of the forum members rolling around on the floor with laughter at this suggestion as they will go for the maximum return for the minimum outlay but I suggest that they will also have the most problems.

I hope this is of some value.

Regards

Ross

AndrewC

10-10-2002, 01:28 PM

Thanks Ross

Your comments/experience is very valuable indeed. Thanks for sharing it. I especially like your 'put people first' attitude -- while not ignoring the fact you are operating a business/investment with a profit motive, this is an enlightened holistic approach that generally pays in both returns and follow-on business in the long run!

As an aside, I was curious about the text book answer to the question. Subtracting both the interest cost and imputed rent from the purchase price seemed overkill. So I set up 3 scenarios on a spreadsheet and "solved" the buy price to achieve the same return in each case -- assuming 70/30 loan/equity required.

The scenarios were:
1. Buy the shop already tenanted.
2. Buy the shop with same quality tenant guaranteed in 6 mo (fund first interest payment with equity)
3. Same as 2 but capitalise first interest payment.

Comparing scenario 2 to 1:
The buy price in 2 was (rent + interest + 8%) less than 1.
Loan was less, interest payments were less, all up equity about the same.

Comparing scenario 3 to 1:
The buy price in 3 was (rent + interest - 12%) less than 1.
Loan was less but more than 2, interest payments were less, and equity less. Essentially we are funding the first interest payment with 70/30 debt equity -- so it is cheaper from an equity return point of view.

So what does all this mean?
Well it seems that if you subtract rent + interest (holding) costs over a vacant period from the buy price it is a good approximation. Its a bit of a double whammy isn't it -- because it seems that all you are missing out on is 6 months of rent payment on a cash flow basis when comparing the scenarios. So vacant periods are very bad and pull down your returns very quickly.

It also means that you should be prepared to pay up to 6 months (rent + interest) to get a tenant in immediately!!

regards, Andrew.

dionysus888

10-10-2002, 02:55 PM

Also keep in mind that a shopping centre operator may be charging a % of turnover as well as a base rent.

Ross Sneddon

10-10-2002, 03:32 PM

Hi Dionysus888

Yes you are quite correct. Shopping centres have more ways than enough to get their hands in your pocket.

I am going to attempt to highlight a number of differences between a Commercial lease and a tenancy agreement on which the forum may comment.

I thought I would have it done by now but the clock has a sprint on.

Regards

Ross

Ross Sneddon

10-10-2002, 04:10 PM

G'day Les

Your comments and my responses.

I will attack your thread in two parts, all the first and the last paragraph seperately.

The love of my life has reminded me that we are to join a group of friends later today and head off up the Hunter for three days. It seems I have to eat a fair bit of food and keep on tasting even more of the grape juice. Hell of a job but someone has to do it. Time is my enemy just now so here goes.

1 Thanks for the TAB advice. Next time I won't try indenting by TAB

2 Challenging exercises - Mike has a book full of them. Steady Mike or we will all be on Panadol by the end of the month and Valium next month. But great.

3 Les - Rates per square metre.

My feeling was this:

Shop A had something different about it. A National Franchisee would have strict criterion to stick to. Someone else said, proximity to a bus stop, pedestrian traffic flow, truck loading dock, corner location, good visibility and what else. A lessee such as this would pay extra for these features but still try and screw for the best deal. Therefore the new owner was content with 6.9% Maybe a valuer may suggest a little less for the shop, say $3,000 psm - $220,000 total. But then he wouldn't have won at auction.
Purchase price is $3,135 per square metre average.

Shop B. I think that this is the solid middle of the road lease. A good tenant, purchase price is OK, and rent seems about right with a rental yield of 9% and no doubt increasing with time.
Purchase price is $2,500 per square metre average.

This is the lease I chose as the yardstick.

Shop C. The new owner bought this shop for $228,500 which gives him a rental yield of 14%. Based on shop B, this is a canny buy and congratulations to the new owner. I feel that he could have gone up to a higher bid and still done alright with a slightly lower rental yield, but hey, he won on the day at auction.
Purchase price is $1,632 per square metre average.

Shop D. I have princiaplly continued to use shop B as the yardstick, discounting Shops A & C and arrived at the figures of $2,413 psm

I don't quite follow your comments of $5/psm, $15 PSM and $25 psm. I'm wondering if you miscalculated and lost a zero. I mean the purchase price of $2,500 psm etc with all the zeroes.

I am almost seperating the Shops A, B, & C by $500 psm and then slipping Shop D in at $2,400 psm.

I'll end this thread here and attack the last paragraph later.

Regards

Ross