Commercial Property

Have noticed that commercial property seems to be discussed rarely on this forum. Personally I’ve had no experience with it but have started paying close attention to it lately. I know the obvious risks involved with this type of investment (long vacancies, higher costs) but with the low yields on res property commercial seems move and more attractive.
Some questions I have are:

1. When advertised with an existing lease of say 10 years, how secure would that be say in the event of tenants being able to break lease etc.?
2. I’ve heard that a commercial properties worth is based on its return, if that’s the case then what percentages would be the industry rule when calculating a properties worth?

Basically throwing this open to anyone experienced in commercial property, any discussion or information regarding commercial or industrial property, others peoples experiences on anything related to this form of investment etc etc etc……..

Piffin.
 
Hi Piffin

When I bought the Bank the expected rental return in strip shopping centres was unnaturally high - in the Outer East, up around 14%, which really reflected the depressed capital values.

In fact, at the next rate valuation (each 2 years) the value was decreased and the council rates went down!

However, in the past six - twelve months there have been a few sales in the CBD Croydon, and returns are now running around 6.5 - 7.25%. Much better from my point of view, perhaps not so good if buying in.

Keep in mind that closer to Melbourne CBD returns vary from not much at all to around, say, 4.5%. This is a 'before expense' return, and as the tenant usually pays all outgoings associated with the building, the rent is a net return which probably add a percentage point or two when factored to the 'true' return.

Rents and capital value are in inverse ratio with commercial, and 'good' or 'bad' depends on whether you are buying or selling.

Piffin, the cycle is slower and flatter than in residential. For example, if you have a tenant with a lease of, say, 5 years with 3 x 5 year options, and you accepted an at or below market rent to tempt the tenancy, you may not have a review period for, say, two years, and then it may be at CPI for the next two rests, then 'market reviews' for the commencement of the next option.

Rents must be agreed not less than three months and not more than nine months prior to the next lease commencing.

So, if the rent is, say, $20,000 per annum, and this reflected a capital value of, say, $200,000, the yield is 10% (easy!)

Three years later, no sales have happened in your area and very few vacancies, landlords are holding rents to keep stable tenants, you've waived review increases, everything is in a holding pattern.

Six years later, a few properties change hands, but rents haven't increased much, so the $20,000 at 6.5% yield means the property is now worth $307,692.

Ideally, both capital value and yield increase numerically, even if the yield expressed as a percentage remains effectively the same.

Remember, retail, commercial and industrial property is a specialist field. Buildings become redundant quite quickly - fire services, staff amenities, parking requirements, loading access, etc Businesses fail, or grow and move to larger premises.

People have to live somewhere, people don't have to have businesses.

However, if you choose well, your commercial property will become the 'Jewel in the Crown' and will reward you handsomely over the years,

Hope this has been of some help

Regards

Kristine


PS When negotiating the opening rent, it is better to allow one or two months rent free, than it is to accept a lower base rent.

why?

Because all your increases are factored against 'annual rent'. The base rent should be written up as $24,000 per annum, with a special condition 'the lessor will allow the lessee a period of two months rent free from the commencement of the lease'.

Enjoy!


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Confucious say: She who has laptop and think everything exciting will go a long way.
 
Hi piffin,

I am seeing more and more res investors looking towards commercial............ this in itself may be a cause for concern....

the 1st consideration has to be ROI. With a bigger deposit required to purchase the returns must still add up.

when buying commercial you are essentially relying on the strength of the company who is leasing off you. If they break the lease is it worth chasing them?

Like any investment the value is related to the yield.

however this yield moves just like residential property yields do.

(depending largely on demand).

IMHO .....commercial vs residential ? it comes down to the figures and potential of each individual deal.

happy hunting


rossv
 
What they said plus interest rates will be generaly higher on loans unless you have a huge deposit.

IMHO best fianance deals can be done with 40% deposits and costs on properties 250K or higher, thats a lot of capital to put in though.

100% finance stand alone deals can be done, if you know the right people.

Realistic rentals have to be checked when your buying as some are sold on inflated rentals especialy on short term lease back. Government departments and debanks are good at playing that game.

Residential investors crossing over have driven prices in Adelaide up recently, some of them will get more than there share of pain with a vacancy or interest rate hike. Reasonable prices can be found if you look at some of the smaller agents around, have to be quick to move though as those deals don't last long in the current market.

bundy
 
As Rossv said "If they break the lease is it worth chasing them?
"

Many businesses close down, and the Landord just isn't going to get paid. And chasing them probably would not do much good.

The building is often tailored to the tenant ? You need a new tenant that wants the same, or YOU go to an expense to modify for the Tenant.

I've looked at the returns, and yes they seem good, but i'm not that much of as gambling man myself. :)

regards

ABCD
 
As a postscript

I did not put one dollar ($1) into the Bank deal.

For finance - It's all in the structuring

For the purchase itself - It's all in the choosing.

I paid $10,000 too much at auction.

But I bought Prime Real Estate.

The footprint is A1.

At some later time I will build a second story, either as extra retail, office or residential space.

Cheers

Kristine

Oh! Dear!

Dare I say -

* Use a good Buyer's Agent / Property Consultant
* Use a good independent Finance / Mortgage Broker

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Confucious say: She who has laptop and think everything exciting will go a long way.
 
Kristine, rossv, bundy and ABCD

Just the sort of input I was hoping to see, seems commercial property not for those that like the sleep easy factor.
I currently have two res. IP’S and PPOR, like the thought of commercial property and always interested in gaining knowledge in all areas.

Thanks for your input.

PS: who sleeps anyway.
 
Piffin,

My own thoughts.

.Yield will probably depend on the reliability of the tenant
.Loan conditions can be different. The last time I investigated a combined unit on top of a shop, the conditions were a 70% lend (which killed it for me anyway) with no LMI for borrowing more- and it was a 10 year P&I- which killed cashflow

But other peopless' thoughts?

Mike put some excellent posts quite a while ago. There's one here but there were others at about the same time.
 
Originally posted by geoffw
.Loan conditions can be different. The last time I investigated a combined unit on top of a shop, the conditions were a 70% lend (which killed it for me anyway) with no LMI for borrowing more- and it was a 10 year P&I- which killed cashflow

But other peopless' thoughts?

I guess GW you went and seen debank and in commercial deals that usualy means a worse deal than the non bank lenders.

Right broker can find you a deal that puts money into your pocket and the wrong one can cost you money on the same deal, even the lender said don't bother using X again deal direct with us and save 4K in fees.

bundy
 
There are considerable differences between commercial and industrial properties compared with residential real estate. I have owned commercial properties for over 20 years and found the main differences to be:-

1. Commercial properties tend to yield a higher return than residential properties – usually between 7% and 10% net; compared to residential properties which yield 3.5% to 5% gross (then you still have to pay the rates, taxes, insurance, etc.) The professional investors require a higher rental return from their commercial properties to make up for the longer vacancy factors and potentially higher risks and possibly poorer capital growth.

2. With commercial properties the tenants usually pay all the outgoings such as rates, taxes and insurance, while with residential property the landlord pays these.

3. Leases for commercial properties tend to be for longer periods, often 3 to 5 years as opposed to the one year lease you get from a residential tenant.

4. Because your tenant conducts their business from your commercial property, they tend to look after it better than residential tenants do, usually maintaining and painting the property.

5. I find commercial properties less management intensive – in fact we manage our own commercial and industrial properties, but I hand over the day to day management of our residential properties to a property manager – I don’t want to be bothered with leaking taps.

6. Lenders will usually only lend up to 70% of the value of commercial or industrial properties. I don’t know of any mortgage insurers who will lend on commercial property. This means the investor needs to come up with more equity to purchase a commercial property.

7. The initial capital required to get in to a good commercial property is usually considerably higher than that required for residential properties, as a good shop or office in a strong centre may cost 2 or 3 times the price of a unit or apartment. Sure you can buy cheap shops in secondary centers, but they will usually have secondary tenants who are more likely to go broke and leave you with a vacancy.

8. Interest rates for a loan on commercial properties are usually higher than for residential properties- at present about 1% higher.

9. When vacancies occur in commercial properties they are often vacant for considerably longer periods than the week or 2 you may have a residential property vacant. How often have you seen a shop in your community shopping centre vacant for weeks or months?

10. The cycle for commercial properties is different to that for residential properties and is even more dependant on the general economic factors than the residential market.

11. The lease required on a commercial property is much more complex and usually requires a solicitor to prepare it.

12. It’s easier for you to pick a top performing residential investment. Most beginning investors know what to look for in a residential property – they have lived in a house, but few would know what a tenant looks for in a good commercial or industrial property unless they have conducted their own business from one.

My personal experience owning a number of commercial and industrial properties is that while we have had no vacancies over the last 15 or so years (as one tenant moved out another moved in because we have owned the right type of property and manage them ourselves), our capital growth on these properties, even though they are in prime positions, has been poor compared to the growth of our residential properties.

In general I believe residential property is a safer choice for the beginning property investor, but as you become more experienced and have more substantial assets you could consider adding commercial properties to give your portfolio some balance.
 
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