In an investment world where high yields are becoming increasingly difficult to find, commercial property offers investors unrivalled cash flow – high enough to generate a significant passive income even after bank debt has been taken on.
Below are some important things to look out for when entering the lucrative world of commercial property investing.
“If you find that it will take more than six months on average to find tenants for a property you’re interested in, this should probably be a market you avoid. The market is telling its own story, and you’re likely barking up the wrong tree.”
Always check the numbers
Since agents represent the seller, they often present approximate numbers as outgoings, or generally underestimate the numbers to help the vendor get a better price. In some instances, they’ve done their best to present the exact correct information regarding a property (it’s in their best interest to do so), but they’re been supplied the incorrect information from the vendors themselves. The bottom line is, always check the outgoings.
Take the example of a client who we recently saved a lot of money. We came across about A$5,000 (US$3,700) worth of outgoings that the agents had missed in their information memorandum. It might not sound like much, but when we calculated it back against the advertised yield, it had a huge impact on the price. What was advertised as an 8.18 per cent yield was now down to 7.83. From our point of view, the fairest result was for the vendor to lower the price to secure the original 8.18 per cent net yield. So we asked for a A$50,000 (US$37,000) discount prior to going unconditional on the contract. This didn’t get us to the exact 8.18 per cent, but it got us within reach of it, at 8.11 per cent. After a lot of hard back-and-forth negotiating with the agent/owner, they accepted the discount request and the property settled a month later.
As you can see from the above example, even a A$5,000 (US$3,700) variation in outgoings had a major impact on the price, and if you don’t carry out proper due diligence, you may end up with a property that’s not generating the assumed income, which can mean overpaying for the property when it’s too late to renegotiate the lease.
Key takeaway: Don’t rely on the advertised numbers. Crosscheck absolutely everything.
Properties with excellent relettability qualities
Buying properties that can be relet without difficulty is a cornerstone of good investing. It’s important to know that if you lose a tenant, you can market the property and find one sooner rather than later, leaving you with an uninterrupted income stream. There are plenty of stories about commercial properties having longer vacancies compared with residential, and they’re true, for low-quality commercial assets. A high-quality commercial asset, in the right location, will have much shorter vacancy rates, and these are specifically the properties that we source for our clients at Rethink Investing.
The best way to find these high-quality commercial assets is knowing the leasing market extremely well. Speak with as many rental managers as possible to determine how they feel about the market on the ground, but also keep in mind that some people will have a vested interest in talking you into or out of a deal, especially if you are buying a property from a competitor. Unfortunately, there are no shortcuts for investors; you’ll need to allow time. The key is finding similar properties you can compare to the one you’re trying to buy.
One trick we use at Rethink Investing is to compare similar-size vacant properties online to see how long they’ve been on the market. CoreLogic, for instance, provides the ability to source the data on the average vacancy period of similar assets and qualify it to, say, a three to four months’ vacancy, which is a workable period you can allow for with commercial property.
A general definition of the vacancy periods we use:
• 1–2 months: Very tight market with minimal leasing risk.
• 3–4 months: More balanced market with minimal leasing risk.
• 5–6 months: Slightly weaker market with moderate leasing risk.
• 7–12 months: Weaker market with higher leasing risk.
• 13–24 months: Extremely weak market with an unacceptable leasing risk.
Key takeaway: If you find that it will take more than six months on average to find tenants for a property you’re interested in, this should probably be a market you avoid. The market is telling its own story, and you’re likely barking up the wrong tree.
Scott and Mina O’Neill are co-authors of Rethink Property Investing and founders of Rethink Investing, Australia’s number one buyers’ agency for commercial property investors. After retiring at the age of 28, they now live off the passive income generated by their personal $20 million property portfolio.