Estimating buy price - Part 2

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....

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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...51506/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.
 
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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,
 
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%.
 
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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
 
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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
 
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
 
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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.
 
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.
 
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,
 
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
 
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
 
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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
 
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.
 
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
 
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
 
Ross,

From previous posts:-

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).

I missed the significance of your comment - you actually said "...valuation of around $2,000 psm for a purchase price" - while I was comprehending it as a rental $/sqm - hence the "lost zero bit".


Ross>> "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."

And, as above, I was considering rental rate when mentioning going down $5, $15, or $25. Now I know where you're coming from, I should be able to follow your comments in future. Thanks for taking the time to expand further. I look forward to your thoughts re the last paragraph (probably after the weekend ?? Enjoy !!

Regards,
 
BUMP! 4 years later...!

What a good thread!

Too late for bids, but I would have signed a contract only subject to having the mentioned tenant sign the lease to move in, in 6 mths time, and with a 6 mth settlement period. But, not sure if these 'subject to' clauses would have been possible in an auction.

I used the average rent of shops A, B and C as $223/m2. So for shop D, 223 x 116 = $25868 rental pa.

Then a yield of 8%, in between shops A and B, to get a value of $323350 as my maximum bid, for shop D, with no other adjustments assuming the subject to clauses are part of the deal - so, I would have won!

GSJ
 
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