Com Prop to provide income

[jingo]

I am at the stage whereby moving from resi to com property makes great sense. I wonder whether experienced investors (com, resi, etc) would be able to provide some feed back on the scenario below.

1) Investor has a number of resi IPs. (ie me). Looking to derive an income from them sooner rather than later.

2) Strategy - sell down the Ips to realize cash of 1.4M (approx) after costs (capital gains, selling costs, etc).

3) Invest the money into a com property. Either outright or with borrowings as per the scenario below:

a) Buy a property like this. (Please note, this one has been sold - but just using it as an example).

http://www.investmentportfolioauction.com.au/recent_auction_sales.html

Price: $3,255,000. Rental return: $325,000 ie 9.9% return.

Pump the cash of 1.4 M into the deal, borrow the rest. I'm not sure of closing costs, but lets say stamp duty & costs amount to approx $200,000. (Please state if I am on the wrong track with this).

Would need to borrow: $2,055,000 * 9% = $184,950 interest costs per year. (LVR 63% - quiet high??)

Leaves $140,050 per year for income.


Pros as I see them:

1) Enough income for me to be able to live on.
2) Long lease with options (15 yrs plus plus)
3) Rental growth of 3% p/a.
4) No more resi tenants, and their pesky demands!

Cons

1) Not sure whether the loan could be continually rolled over at the end of the term, or whether it would need to be paid down over time??

2) All eggs in one basket - not wise.

3) Vacancy risk


I'd appreciate people's thoughts, ideas etc. Is this too simplistic? What have I forgotten to consider?

Other strategies that I can consider are:

1) Keep IPs and use equity from them to buy a lower cost com prop. (No need to set up a com loan, as would use LOC's etc from existing portfolio) Pay down the com prop slowly over time.

2) Borrow to buy a couple of smaller com props - using equity from resi to fund deposits. Set up in trusts, pay down over time.

3) Invest in shares over time to derive income.



Thanks in anticipation.

Regards Jason.

 

[Rolf Latham]

Hi jason

You wont need to pay 9 % for any form of decent bill backed loan on that volume as long as the security ( ie tennant and lease quality is good)

ta
rolf

 

[Scott No Mates]

Commercial property is a long-term hold. Obviously returns are dependent upon the quality of the property, the quality of the tenant and of course the rent reviews. You're best chance of making money is to buy at the right price. Ie you will need to research & do your due diligence.

Is the lease term a straight 15 yrs + options or 5+ options?
Are there reviews at each rollover of lease or are there fixed increases throughout the term & options?

Banks will have their own criteria for borrowing - LVR probably around 60-70%.

Is it a gross or net rental (ie outgoings paid by the tenant)?

Will you be using a property manager or self-managing (may be covered in your outgoings clause as fees could be payable to a manager at no cost to yourself, cutting the manager out may mean doing the work yourself without compensation).

As commercial property tends to have longer vacancy periods, is it a specialised property? If it became vacant, how long would it take to find a replacement tenant? Is the space adaptable to other uses?

As you point out, having one commercial property is a riskier proposition. Is there any way of holding on to one (or more) of your IPs & borrowing against these?

 

[Aaron_C]

Scott's summed it up pretty well. There are classes within classes for Commercial Property. The main types, in order of yield, are:

Retail (Shops)
Offices
Specialised Securities (Petrol Stations, Hotels/Pubs, Motels etc)
Industrial/Manufacturing

Whichever one you go for depends on your risk tolerance, but the most important thing is can your tenant pay the rent, will they pay the rent, will they stick around if you increase the rent, and if they leave, how likely is it that someone else will come and pay the high rent?

I see that you are in Melbourne, so a rough guide of the yields are:

Retail - ranges from high 3% (in CBD) to 7% (in Suburbs)
Offices - 7% in CBD, higher in suburbs
Specialised Securities - Petrol Stations can go for ~9% yield, Hotels/Pubs around 10-11%.
Industrial/Manufacturing - 10%+

Obviously, the bigger the property, the higher the yield. I find that commercial properties below $3m are the crappy ones. This is because they are populated by 'mum and dad' investors who, like you, are buying their first CIP. The CIPs for sale in this space are usually on the market because the landlord knows the tenant/s are late with rent and are not going to renew their lease option. The new purchasers lack experience, knowledge and are only chasing 'yield yield yield'. They get misled, they get ripped off because as soon as they buy the property, the tenant/s leave, and their investment remains empty for many many months.

I think for something decent you have to get something ~$5m - as this is where the professional investors lurk and usually the quality of stock is far better. This is just my opinion, but this is what I've seen happen to my own friends.

BTW as Rolf pointed out, comm interest rates rarely go to 9% unless you are a weak borrower, are going lo-doc or the security is crap You can expect mid 7s or low 8s with a max LVR of 70%. Some lenders go up to 80% but you pay 13% pa interest

Best of luck with it.

 

[jingo]

Hi Scott and Aaron,

Thanks to both of you for your comprehensive feedback on research to undertake and things to look for in leases etc.

If I was going to buy a com prop, I would have it professionally managed. Certainly worth the money for the peace of mind.

Aaron and Scott, the other possibility I would have is using resi equity to buy two smaller coms (ie $800,000 mark or so) Do you or other people think this is a valid foray into com? My idea would be to buy two neutral coms set up in a trust (or two trusts) and pay them down over time - which could include selling down some of the ip's to pay down the debt. The idea of doing this is to produce income.

I take your point below about the better coms being worth 5M plus - I am not in a position to take advantage of these at this stage, and doubt I ever will be! (Unless I want to work until I'm 65, which I don't!)

Obviously, the bigger the property, the higher the yield. I find that commercial properties below $3m are the crappy ones. This is because they are populated by 'mum and dad' investors who, like you, are buying their first CIP. The CIPs for sale in this space are usually on the market because the landlord knows the tenant/s are late with rent and are not going to renew their lease option. The new purchasers lack experience, knowledge and are only chasing 'yield yield yield'. They get misled, they get ripped off because as soon as they buy the property, the tenant/s leave, and their investment remains empty for many many months.

I think for something decent you have to get something ~$5m - as this is where the professional investors lurk and usually the quality of stock is far better. This is just my opinion, but this is what I've seen happen to my own friends.

Regards Jason.

 

[Aaron_C]

Jason,

I think from your comments you are looking to have the CIP as a long-term hold to provide income for you to retire. In which case, paying off the principal as fast as possible isn't a bad thing to do. Just bear in mind that commercial property loans are usually for 15 years (Rather than 30 years), so the mandatory P&I payment will be much higher.

Trusts will work well for CIPs, because of the larger sums involved. Whether you use a unit trust or discretionary trust is up to you, you would need to run the numbers on either case to see which is more worthwhile.

As I have said before, I would try to purchase 1 bigger CIP rather than 2 smaller ones. If you purchase a small shop, you attract tenants who are running their first business, and are most likely to go broke within 2-3 years. Plus you have to abide by the Retail Leases Act which is annoying. With a bigger CIP (even if it's not $5m like I suggested), you generally get a better quality tenant which means better income and stability. Just make sure you always check the lease with a fine toothed comb.

 

[jingo]

Jason,

I think from your comments you are looking to have the CIP as a long-term hold to provide income for you to retire. In which case, paying off the principal as fast as possible isn't a bad thing to do. Just bear in mind that commercial property loans are usually for 15 years (Rather than 30 years), so the mandatory P&I payment will be much higher.

Yes, this is right - I think having a CIP debt free (or nearly so) would make a secure income stream for retirement. I have read on here that longer loan terms are possible with commercial property? Although, you are right - payments would be high. It would be ideal to fund them from the com property and other investments if possible.

Trusts will work well for CIPs, because of the larger sums involved. Whether you use a unit trust or discretionary trust is up to you, you would need to run the numbers on either case to see which is more worthwhile.

I would need to investigate this further - thanks for the info.

As I have said before, I would try to purchase 1 bigger CIP rather than 2 smaller ones. If you purchase a small shop, you attract tenants who are running their first business, and are most likely to go broke within 2-3 years. Plus you have to abide by the Retail Leases Act which is annoying. With a bigger CIP (even if it's not $5m like I suggested), you generally get a better quality tenant which means better income and stability. Just make sure you always check the lease with a fine toothed comb.

This is good advise. I was thinking two may be good for diversity - but then again, one better quality property with secure tenants and less hastles would be even better.

Thanks Aaron,

Regards Jason.

 

[Rooster]

2) Strategy - sell down the Ips to realize cash of 1.4M (approx) after costs (capital gains, selling costs, etc).

Jason,

It's precisely the decision I'm trying to come to terms with at the moment.

Do you divest those assets now and re-focus the funds towards a high yielding CIP or do you hold the resi portfolio and draw down the equity to use as a deposit.

The majority of my investments are in Gladstone which should show good upside into the future, however, I'm getting to the point where the expenses of holding these assets and dealing with the various "out of nowhere expenses" is leaving me a little jaded.

I need to somehow assess whether holding the IP's for future upside is the way forward or divest them which will allow a greater initial foray, purchase price wise, in to the CIP market.

Plenty to think about.

Rooster

 

[Player]

I am at the stage whereby moving from resi to com property makes great sense. I wonder whether experienced investors (com, resi, etc) would be able to provide some feed back on the scenario below.

1) Investor has a number of resi IPs. (ie me). Looking to derive an income from them sooner rather than later.

Mightn't be a bad strategy in the current climate. As you are significantly exposed to Melbourne and IMO it's going to track sideways for some time, cashing in and having folding stuff may not be a bad way to go.

You wouldn't need to sell off everything. Do some figures (and maybe think of selling any dogs you have first that may not see upside any time soon) on selling a few and if possible re-valuing and sucking out any excess equity into offsets or LOC.

2) Strategy - sell down the Ips to realize cash of 1.4M (approx) after costs (capital gains, selling costs, etc).

If that's the whole portfolio, then perhaps don't be too hasty with throwing out the baby with the bath water. I mention (and it's merely my opinion) that Melbourne will track sideways for a while, however that's not to say it won't gidee-up again.

3) Invest the money into a com property. Either outright or with borrowings as per the scenario below:

I would use some borrowings (conservative LVR with buffers in offsets or LOC) and some cash. That's what we are looking at doing for the right deal.

a) Buy a property like this. (Please note, this one has been sold - but just using it as an example).

http://www.investmentportfolioauction.com.au/recent_auction_sales.html

Price: $3,255,000. Rental return: $325,000 ie 9.9% return.

Pump the cash of 1.4 M into the deal, borrow the rest. I'm not sure of closing costs, but lets say stamp duty & costs amount to approx $200,000. (Please state if I am on the wrong track with this).

Would need to borrow: $2,055,000 * 9% = $184,950 interest costs per year. (LVR 63% - quiet high??)

Leaves $140,050 per year for income.

Be mindful of income coverage as per Dazz's reply to another thread of yours:

http://www.somersoft.com/forums/showpost.php?p=846367&postcount=10

The brokers may be able to help you there also.




Pros as I see them:

1) Enough income for me to be able to live on.
2) Long lease with options (15 yrs plus plus)
3) Rental growth of 3% p/a.
4) No more resi tenants, and their pesky demands!

Cons

1) Not sure whether the loan could be continually rolled over at the end of the term, or whether it would need to be paid down over time??

2) All eggs in one basket - not wise.

3) Vacancy risk


I'd appreciate people's thoughts, ideas etc. Is this too simplistic? What have I forgotten to consider?

Other strategies that I can consider are:

1) Keep IPs and use equity from them to buy a lower cost com prop. (No need to set up a com loan, as would use LOC's etc from existing portfolio) Pay down the com prop slowly over time.

That may also be a worthwhile strategy if (as I mentioned above) you are able to suck out more equity from your resi portfolio.

2) Borrow to buy a couple of smaller com props - using equity from resi to fund deposits. Set up in trusts, pay down over time.

3) Invest in shares over time to derive income.



Thanks in anticipation.

Regards Jason.

Hi Jason,

you've had some very constructive input from people to date in this thread. I also stress test interest rates at a higher level. When they don't eventuate, then there's a nice bonus to the bottom line also. I am very conservative these days and we've communicated before about various strategies and shared properties that we've each looked at.

You need to ascertain what you want in dollar terms to be free of the shackles of work.......if that's what you want? Or, have the option to work or not.

Then you need to work back from there to arrive at a net (pre-tax) passive income figure to fund your chosen lifestyle for you and your family and still have some buffer for unexpected events.

Personally, I am not liquidating the entire resi portfolio to buy a 3-4 mill CIP cash. I am still keen on having that exposure for growth, however now also looking for net yield. I will contribute cash and have some borrowing however not too much that the bank is arranging financial colonoscopies too regularly.

Whatever you decide, be comfortable with debt levels and LVR. I am more conservative as I accumulate birthdays. It reduces the insomnia index.

Happy hunting

 

[Scott No Mates]

Getting back to a point you raised earlier, you probably could get some decent buying in the sub-$1m range but I would steer clear of anything which is strata & go for some reasonable industrial property, even better if it is already leased with a decent covenant. My experience here is that they are good performers, even better if you have developed them.

If you are looking at a commercial property, you will pay a premium for a quality tenant but the peace of mind is worth while. Here again, free standing properties are best but getting a full floor in a strata building is also a good option.

 

[jingo]

Hi Jason,

you've had some very constructive input from people to date in this thread. I also stress test interest rates at a higher level. When they don't eventuate, then there's a nice bonus to the bottom line also. I am very conservative these days and we've communicated before about various strategies and shared properties that we've each looked at.

You need to ascertain what you want in dollar terms to be free of the shackles of work.......if that's what you want? Or, have the option to work or not.

Then you need to work back from there to arrive at a net (pre-tax) passive income figure to fund your chosen lifestyle for you and your family and still have some buffer for unexpected events.

Personally, I am not liquidating the entire resi portfolio to buy a 3-4 mill CIP cash. I am still keen on having that exposure for growth, however now also looking for net yield. I will contribute cash and have some borrowing however not too much that the bank is arranging financial colonoscopies too regularly.

Whatever you decide, be comfortable with debt levels and LVR. I am more conservative as I accumulate birthdays. It reduces the insomnia index.

Happy hunting

Hi Player,

Thanks for the detailed answers. Certainly appreciated as always. It is a challenge working out the best strategy moving forward.

Starting with the desired income and working backwards is certainly a help. I wouldn't be too keen to sell down the whole IP portfolio - especially at this stage. But certainly selling a few to fund a com prop of some description may be the best way forward.

Yes, Dazz's post regarding income coverage is certainly something to keep in mind.

Thanks again Player.

Regards Jason.

 

[jingo]

Getting back to a point you raised earlier, you probably could get some decent buying in the sub-$1m range but I would steer clear of anything which is strata & go for some reasonable industrial property, even better if it is already leased with a decent covenant. My experience here is that they are good performers, even better if you have developed them.

If you are looking at a commercial property, you will pay a premium for a quality tenant but the peace of mind is worth while. Here again, free standing properties are best but getting a full floor in a strata building is also a good option.

Thanks Scott - certainly great advise. Greatly appreciated.

Regards Jason.

 

[jingo]

Jason,

It's precisely the decision I'm trying to come to terms with at the moment.

Do you divest those assets now and re-focus the funds towards a high yielding CIP or do you hold the resi portfolio and draw down the equity to use as a deposit.

The majority of my investments are in Gladstone which should show good upside into the future, however, I'm getting to the point where the expenses of holding these assets and dealing with the various "out of nowhere expenses" is leaving me a little jaded.

I need to somehow assess whether holding the IP's for future upside is the way forward or divest them which will allow a greater initial foray, purchase price wise, in to the CIP market.

Plenty to think about.

Rooster

Hi Rooster,

It's certainly a difficult decision and not one to be done lightly. I think there is no such thing as the perfect investment. Some people would rather keep their resi IP's. Others sell down and go into shares and or com property. Others have a combination of all asset classes.

Everyone has a slightly different opinion on what they think is best. I suppose that most of it is based on their experience with what has worked best for them.

My main reservation in selling down is the loss of so much equity in capital gains tax and selling costs. Ideally, it would be best for me to keep as much as I can and use the equity to go into com property and or shares.

Most people advise working backwards ie how much income do you want - what will get you there in the least amount of time.

All the best with it Rooster,

Regards Jason.

 

[Bird Dog]

Just to add my .02c Jason...
I'm assuming the property you are referring to is the IGA in Dugog and whilst you mentioned it was only an example, I will use some of the info as it will be used, after all as a income stream for you.

As other have stated, retail generally produces the lowest yields but also comes with (arguably) more safety.
To get your 9+%, such as the property you mention, you're looking at a shopping centre in a small town in the middle of nowhere.
The lease if I recall we was something like 5+5+5 which to me represents a little too much risk for a dedicated shopping centre. Yes the anchor tenant is a larger national chain but if they leave, it would most likely be because of lack of business and then you'll be pushing to find a replacement tenant. And everyone knows, a shopping center without an anchor tenant is like a ship without a rudder that will eventually drift into stormy weather.
Again, I know you were only using it as an example but I just wanted to highlight that the additional yield could potentially be mitigated by the higher risk.
The plus side of the premises however it a significant depreciation schedule which could bolster your income stream but again, that is linked to the very nature of a dedicated "tenant specific property" which may not be so favourable in the long term with restrictions as mentioned above.

Scott mentioned newer industrial (non strata) and this would also be my recommended flavour. I still think strata can work well as our most recent purchase was however it's located in such a way that is separate from the rest of the development with it's own separate main road frontage. I wanted this as I had heard nightmare stories of tenants breaking leases due to access issues caused by fellow tenants.
You just need to be mindful of body corp fees and potential restrictions on trade and types of businesses.

Player mentioned you may have significant exposure to the resi Melb market and that perhaps a better idea would be to sell off a few of the dog's rather than the entire portfolio which I also agree with. The insomnia factor in shifting your entire portfolio (which you've obviously worked on over a considerable amount of time) might be too great if you were to plunge it all into one property.

If you're cashed up and willing to take the plunge, why not purchase something smaller and untenanted with a slightly longer settlement date that can be used to look for your own tenant. Once the new tenant is installed, have it revalued and then as they say...wash, repeat.

As an example, we purchased our last one untenanted with a 3 month settlement and had a tenant installed on a 5 year lease 6 weeks after settlement.
Yield is a little under 9% with the tenant paying all outgoings except our land tax. We had some repairs to the roof which we knew about prior to purchase and installation of the tenant and because of it's age, there is no more depreciation left.
Despite that it's still retuning some income into our pockets each year and growing (assuming a 100% IO loan).
If you want to be really generous and include CG, I worked out the previous owners achieved a little under 7% YoY from when they purchased the warehouse back in 1991 (he showed me the original sales contract) so the numbers aren't' bad over the long term.

Anyway, the above is one of many reason why I went commercial over resi.
It's not for everyone and to be honest, I'm quite happy for it to remain that way..

Good luck

B.D

 

[JIT]

Jason,

I would just focus on shares.

Rental growth of 3% pa is nothing compared to the EPS (earnings per share) and DPS (dividends per share) growth you can get with well-selected shares.

Invest the 1.4M into high quality businesses with good forward EPS growth figures, when prices are cheap.

 

[jingo]

Jason,

I would just focus on shares.

Rental growth of 3% pa is nothing compared to the EPS (earnings per share) and therefore DPS (dividends per share) growth you can get with well-selected shares.

Invest the 1.4M into high quality businesses with good forward EPS growth figures, when prices are cheap.

My main reservation with shares is their instability - there is no guarantee that the company you buy into today will be around in 20 yrs. Property will still be there in years to come - and worth something. The same can't be said about shares.

Regards Jason.

 

[Aaron_C]

People keep saying 'just buy some shares and you will make more money than property' etc. Frankly I think it's a bit of a cop-out. You have no control over anything that happens with an ASX-listed company because you don't control the management. So you have both agency and economic risk. Unless you are an active share manager, I think it's something most people just shouldn't do, particularly with leverage involved.

 

[Edmond Dantes]

People keep saying 'just buy some shares and you will make more money than property' etc. Frankly I think it's a bit of a cop-out. You have no control over anything that happens with an ASX-listed company because you don't control the management. ...

I don't really see a difference on this with property. Do you have any control in property? I really doubt it... if, for example, you've bought a townhouse for a really good price, and the following year the neighbour is forced to sell for 50k less than the average price... guess what the value of your property is now? This is really something out of your control. So I think the level of control is probably the same between shares and property.

 

[Aaron_C]

I don't really see a difference on this with property. Do you have any control in property? I really doubt it... if, for example, you've bought a townhouse for a really good price, and the following year the neighbour is forced to sell for 50k less than the average price... guess what the value of your property is now? This is really something out of your control. So I think the level of control is probably the same between shares and property.

That's economic factors, which are common to both shares and property.