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Yes but why would you bother? For me, I would only do it if the commercial rental I get is massively higher than an equivalent resi one. This is because as soon as it is commercial its value is crunched by a higher capitalisation rate which can only be counteracted by a much higher rent.
Hi Aaron,
Could you explain that. Higher capitalisation?
Sure. Consider a property that can be rented out either as resi or commercial, both at $100,000 pa.
Resi properties are valued by comparable sales and rental yield is generally not that important, particularly for inner-city residences. In an inner city area a yield of only 3% may be acceptable - in which case the property is worth $3.3m as a resi security.
Contrast that with commercial - rental yield is everything as commercial properties only exist to make money. The capitalisation rate is the required yield on the property that an investor needs to purchase it. You divide the rental by the capitalisation rate to get the value. Since the security is used for commercial purposes, the capitalisation rate will go up so it will be more than the 3% for a resi property. Perhaps it will be 5%. In which case the value of the property is now only $2m ($100,000 / 5%). So you've lost a massive amount of value - plus your property will be gutted out by the commercial tenant since they need space for offices/shop etc.
To make the commercial security equivalent to the resi one with that cap rate, the commercial rental has to be about $170,000 pa. Is that achievable? If not, then it is a bad idea.
Thanks Aaron. I have heard the concept, never knew what it was called. Have you seen cases where it WAS justifiable?
Yes but why would you bother? For me, I would only do it if the commercial rental I get is massively higher than an equivalent resi one. This is because as soon as it is commercial its value is crunched by a higher capitalisation rate which can only be counteracted by a much higher rent.