Commercial property vs residential

[NomoneyNotalk]

Hi guys,

just accumulated some cash, wanna buy another property in the next month. I've been looking at some commercial property. It has quite good return from what i read, and some other advantages over the residential ones such as:
-Long term tenants ( up to 5 years or more)
-Tenants pay all of the outgoings
-higher rental yield

The advantages are easy to find, If you know any disadvantages, please tell me. I am thinking to buy the ones with ongoing tenants. Something like : 500k purchase price, 40k + gst rent, all outgoings paid by tenants, with 5 years lease. Seems like 8% return on Investment in the next 5 years. So what numbers are hidden in this ad? Maybe there is some cost hidden from that "all out goings paid by tenant" statement?

thank you in advance

[Rosco]

Hi NomoneyNOtalk,

You are correct that tenant should pay all costs, such as rates, insurance and even valuation when rent reviews come up.

Issues are;

- have to deal with GST (extra hassle)
- What happens if tenant goes bust? You could be empty for the next year with 0% return!
- Bank will probably only lend 65%, so you need to come up with $175k cash in your $500k example
- If your tenant moves out, you could be looking at large renovation costs to attract another tenant
- Watch earthquake issues, as many buildings are not up to spec and will require huge costs to get them complient long term.
- Quick pay back time. Bank may require you to pay the loan back in 10 years. So if buy for $500k, borrow $325k, you could be looking at paying back $2,000 principal per month or $3,600 Interest and Princpal repayments per month (from westpac site, with 6% interest). So your rent is only $3,333 per month, so you might be short $300 per month excluding other entity expenses.
- Commercial has a higher interest rate. A client of ours is looking at 6.10% for 3 years as a good commercial rate.

Be very careful with commercial, as even if you have a good property in a good area, it can still sit empty for a year!

If you do go ahead, look at getting a chattels valuation, as you can depreciate building fitout for commercial, so it is even more worthwhile.

My favourite trick is to buy empty and then move your own business in. This way you can generate good gain in value, ie $100k turn into $150k.

Good luck

Ross

[Rosco]

With commercial , landlords often offer deals to get tenants. Things like 6 months free rent, or great fitout etc to get tenants.

Times are hard at the moment, and most businesses are being careful with cash, and not moving to new buildings, and not spending more on rent.

Ross

[NomoneyNotalk]

Thank you for the info Ross. Will take those things into consideration.

I am thinking to buy cash, and buy the one with existing tenant with few years lease to go. Will that make it a bit safer maybe?

[Rosco]

Obviously if you are a cash buyer, then it will be safer as you don't have the major expense being interest.

But still, what happens if your tenant goes bust or even if they just move out after the 5 years? Will it be easy to find another tenant?

Buying a good residential property is safer, as you can always get tenants. But the gross yield might only be 7 to 7.5%, so after costs the return is quite a bit less.

You also need to consider which will give the better growth. Commercial will go up based on increased rent, which you might struggle with for the next 5 or more years.

Ross

[Davo36]

Ok, I'd like to weigh in here. I agree with a lot of what Rosco has said but not all.

NoMoneyNoTalk, what city are you looking in please? This makes quite a lot of difference.

The main thing I think is important with commercial/industrial is the leasability of it. What I mean by this is if the tenant left tomorrow, can you lease it again for the same rent or more easily?

So for this to happen you need:

• For it to be in a fairly good position.
• Not be designed or fitted out for one specific purpose e.g. food industry or car yard or something like that.
• Not require too much in terms of upgrading/fitout to attract another tenant.
• You need to be absolutely sure the rental being paid is fair for the building.

And the last one of those is the most important. As Rosco has said, one of the many tricks that occurs with commercial property is people buying a place, and either renting it out themselves (or an entity associated with themselves like a company that they have a shareholding in) or renting it out to someone else at a high rate, and then upping the value of the building based on that rent.

Then some naive buyer comes along, buys it, and guess what? The business goes into liquidation, they have no assets, so you are stuck with a building which you can only rent for much less. I have seen this done quite a few times.

So what you need to avoid this, is an understanding of what a reasonable rent for a property is in the area. So just as with a residential property, you'd have some idea of what it should rent for, you need to develop this ability with commercial. Which you get from looking at lots of them etc.

And then there are lots more issues depending on property type, location etc. Are you buying industrial? Retail? Offices?

[speights boy]

I agree with Davo.

Olly N has also written a bit about naive buyers buying 'pump and dump' owner occupied commercial.

[Davo36]

I guess taking this a bit further, what you want to do is buy an under rented property...

So next time the rent review comes up, you are able to increase the rent, which increases the value of the building.

So if say, the rent goes from $40k to $44k, then your property is now worth $550,000 (if you can sell it at the same cap rate of 8%). You just made $50k without doing anything much.

[NomoneyNotalk]

hi guys,

Thank you once again for the valuable information.

I was interested in the warehouse on Lincoln Road, in West Auckland. Wanna get some info first before having a look. But it was sold this morning . It has about 7.5% return and a long term tenant with some years left in the lease.

Yes i think getting a tenant for commercial is much harder than residential. But i was thinking once a tenant is in, it would be less hassle than a residential one. Maybe not. lol. And because it is harder to set up a business than to move to a new home, the tenant is less likely to move, unless the business go bust.

And i notice that the number of for lease listing is about 5 times the number of for sale listing. Where in residential, the number of houses for rent is less than the ones for sale. It should confirm that it is much harder to find tenant in commercial property.

Maybe i should stay with residential.

[Tan]

I don't really think you should stay with just residential, in the long term commercial is best. I was going to have my say when I first saw this thread, but being lazy waited for Davo to reply, and he has said it exactly as I hoped.
With Commercial you need to have a bit more of a cash buffer, mainly for between tenants and keeping up with modern ideas.
There are offices, retail and industrial to decide between, each has pros & cons.
Go to your PIA meetings, surely in Auckland they have some commercial focus or a seperate group? If not, hunt out a mentor and start learning. It will be an excellent investment.
I love Ollies books but they may put you off! It is a whole different ball game, and you need to know how it works before getting into it. Ie, I have noticed a lot of private landlords don't get their tenant to pay for many of the things they could.
Perhaps start off by going to a managing company and have one managed one while you learn.
A guy I know who may help you buy and/or manage it is Glover Property, google his web site. Not sure of many others who will help you as much. He started in residential and now does both in Auckland & Tauranga.
Good luck.

[NomoneyNotalk]

Thank you Tan, so commercial also has property managers like residential? I will search for that Glover property. I am planning to start with the easiest and hopefully learn something before buying more. So i probably would start with something small, already tenanted, and buy cash for it.

I don't really think you should stay with just residential, in the long term commercial is best. I was going to have my say when I first saw this thread, but being lazy waited for Davo to reply, and he has said it exactly as I hoped.
With Commercial you need to have a bit more of a cash buffer, mainly for between tenants and keeping up with modern ideas.
There are offices, retail and industrial to decide between, each has pros & cons.
Go to your PIA meetings, surely in Auckland they have some commercial focus or a seperate group? If not, hunt out a mentor and start learning. It will be an excellent investment.
I love Ollies books but they may put you off! It is a whole different ball game, and you need to know how it works before getting into it. Ie, I have noticed a lot of private landlords don't get their tenant to pay for many of the things they could.
Perhaps start off by going to a managing company and have one managed one while you learn.
A guy I know who may help you buy and/or manage it is Glover Property, google his web site. Not sure of many others who will help you as much. He started in residential and now does both in Auckland & Tauranga.
Good luck.

[Tan]

Yes, there are commercial property managers.
Go for it, good luck. There are some guys on here and old commercial posts that will help with any queries you have.
If you buy a place with a sitting tenant, get someone who knows leases to go over it slowly with you so you understand all the ins & outs. I know a lot of people don't like legal documents, but the best thing I did when I started working with commercial property was read a standard lease slowly and ask questions.

Be happy you are not in Australia - there is no standard lease document here - or not in WA at least. As soon as I saw the situation I switched to residential management which I never would have done in NZ.

[Davo36]

And i notice that the number of for lease listing is about 5 times the number of for sale listing. Where in residential, the number of houses for rent is less than the ones for sale. It should confirm that it is much harder to find tenant in commercial property.

You know why this is? It's because soooooo many commercial landlords are hanging onto their properties! Where else are they going to put their money?

So it's actually a good thing. The commercial/industrial property market is running hotter than the residential ones at the moment.

[Ivan McIntosh]

Just personal opinion - I see a fair bit of upside in office rents starting this year.

One cost not yet mentioned with commercial is agent fees...generally two months worth of rent for finding your new tenant.

In tough times for landlords, I think you should budget approx six months worth of fitout and rent free period to get a six year tenant in. It's all a matter of negotiation though - if the property is hot enough the landlord can even charge tenants substantial lump sums for the privilege of renting it.

[NomoneyNotalk]

Wow, it's getting interesting . So i think it's like catching a bigger fish in commercial investment, it's harder to catch, but once caught it's sweet.

I have booked some appointments with an agent to show me some commercial on my next Auckland adventure on March. I will post the experiences in this forum to share.