Expected Commercial Net Yield in Auckland

[chrisgoh]

New to commercial property, need some advise.

I am looking at a commercial property, offering 5.5% net yield. It is a freehold unit managed by a body corporate. So far, it has never suffer a day of vacancy since day one. The area enjoy high traffic and good in demand. The tenant has just continued with a new tenancy agreement, and has been running the restaurant for good many years. Read the latest Body Corporate meeting minutes and it seems to be all in order except one unit requested reimbursement for a water leak repair and was approved. The existing landlord holds the property since new.

Questions:

1. Tenant pays all outgoing. Is there any hidden cost I need to be aware of?
2. Are all the shops insured by group insurance purchased by Body Corporate as part of the Body Corporate fees? Is there a need to separately buy insurance for my shop unit?
3. If half of my rental income from residential rental and another half from commercial, do I need to register GST if the combine income exceed $60,000?
4. Being GST registered mean I have to pay GST for commercial property purchase. This GST paid can be reimbursed during IRD filing right? So what is the purpose of paying GST and collecting it back at the end of the day?
5. My target is net yield 6% or more but it seems to be challenging to achieve for good commercial properties. Unless I buy leasehold or risky commercial properties. Is 5.5% net yield a norm or acceptable for such commercial property in Auckland?
   The yearly rent review would have improve the yield over time?
6. Any other advise is welcome. Thanks!

[Davo36]

1: Maintenance. Things like repairs to roofs are not covered - although being in a body corp this might be shared.

2: Shared insurance, you don't need your own.

3: Dunno, question for an accountant.

4: These are usually zero rated now - if both parties are GST registered. Which means you don't pay any GST and you don't claim any. Again, speak to an accountant.

5: Yeah yields are very low nowadays. 5.5% is probably not bad - but of course we don't know anything about the property.

Since this is your first one, get your lawyer to read the lease. How long is the lease term?

[Scouser]

Most of your questions are about understanding the lease - if this is your 1st commercial property get a lawyer who does these - some have more experience than others and get them to check the lease. There are multiple base versions of the standard lease agreements and many have manual changes from the base agreement. It's messy.

On 2 - you really have to register for GST to be able to purchase the property as an ongoing concern so that you don't have to pay GST on the purchase. It strikes me as strange to own a commercial property and not be registered for GST. I own our properties via a company because even though there are overhead costs it means I can just sell the company rather then the properties if I wanted to.

5.5% per cent is IMO at the bottom of the yield range depending on location and other factors but smaller properties generally have more purchase competition so it drives down yields.
- Foreign purchasers were helping drive the yield down and there are less of them around - I recently saw one new retail complex where 2/3rd of the 20+ properties were bought by foreign investors at low yields and once they dried up the yields went up.
- Banks are more wary at lending, which will potentially push yields up
- the lease can be done in such a way that various costs are the owners (I had one were some specific costs had been crossed out and I missed it)
- the landlord may own assets that he/she has responsibility for eg AC units - not the maintenance rather the replacement at the end of their life - I've seen restaurants where the landlord owner all sorts of restaurant related assets in the asset register and had to replace at end of life.
- contributions to the sinking fund of the BC are often the responsibility of the landlord (though not in the latest standard agreement) - though when the BC spends the sinking fund that can typically be costed back to the tenant if it's not significant repairs - I checked with a lawyer - even had to point this out the BC manager who thought otherwise.
- I presume it's new enough to have no earthquake standard issues?
- the lease may have crap or great rent review terms and may have them locked in for long terms.
- are there personal guarantees on the lease?
- how much is in the sinking fund
- as it's a newly re-signed agreement there's unlikely to be much room for any significant gains in yield for some time so you're probably buying at full value and no discount
- etc etc

Any and all of the details above can turn what is a decent looking property in to a poor purchase. Certainly, there is a reasonable chance you're buying near the peak on capital values so making sure one gets a decent yield is important as we've had capital gains for a while and the market could be ready for a pause.

Most of this will be pointed out to you by a decent lawyer as Devo says.

[chrisgoh]

1: Maintenance. Things like repairs to roofs are not covered - although being in a body corp this might be shared.

2: Shared insurance, you don't need your own.

3: Dunno, question for an accountant.

4: These are usually zero rated now - if both parties are GST registered. Which means you don't pay any GST and you don't claim any. Again, speak to an accountant.

5: Yeah yields are very low nowadays. 5.5% is probably not bad - but of course we don't know anything about the property.

Since this is your first one, get your lawyer to read the lease. How long is the lease term?

Thanks Davo!

The new lease term is 2+2 with yearly rent review.

[chrisgoh]

Most of your questions are about understanding the lease - if this is your 1st commercial property get a lawyer who does these - some have more experience than others and get them to check the lease. There are multiple base versions of the standard lease agreements and many have manual changes from the base agreement. It's messy.

Yes, will consult a property lawyer.

On 2 - you really have to register for GST to be able to purchase the property as an ongoing concern so that you don't have to pay GST on the purchase. It strikes me as strange to own a commercial property and not be registered for GST. I own our properties via a company because even though there are overhead costs it means I can just sell the company rather then the properties if I wanted to.

Make sense. Will consult an accountant about my plan.

5.5% per cent is IMO at the bottom of the yield range depending on location and other factors but smaller properties generally have more purchase competition so it drives down yields.
- Foreign purchasers were helping drive the yield down and there are less of them around - I recently saw one new retail complex where 2/3rd of the 20+ properties were bought by foreign investors at low yields and once they dried up the yields went up.
- Banks are more wary at lending, which will potentially push yields up
- the lease can be done in such a way that various costs are the owners (I had one were some specific costs had been crossed out and I missed it)
- the landlord may own assets that he/she has responsibility for eg AC units - not the maintenance rather the replacement at the end of their life - I've seen restaurants where the landlord owner all sorts of restaurant related assets in the asset register and had to replace at end of life.
- contributions to the sinking fund of the BC are often the responsibility of the landlord (though not in the latest standard agreement) - though when the BC spends the sinking fund that can typically be costed back to the tenant if it's not significant repairs - I checked with a lawyer - even had to point this out the BC manager who thought otherwise.

Thanks for the insight!

- I presume it's new enough to have no earthquake standard issues?

The owner did not have IEP report. The BC management are not planning to get the report until it is pass into law. The building was built around 1980s, seems to be in good condition.

- the lease may have crap or great rent review terms and may have them locked in for long terms.
- are there personal guarantees on the lease?
- how much is in the sinking fund
- as it's a newly re-signed agreement there's unlikely to be much room for any significant gains in yield for some time so you're probably buying at full value and no discount
- etc etc

Yes, the tenant personally guarantee the lease.
No idea about the sinking fund, need to find out.
You may be right about limited upside although the lease agreement indicate yearly review. Need to do more research on the surrounding similar rentals.

Any and all of the details above can turn what is a decent looking property in to a poor purchase. Certainly, there is a reasonable chance you're buying near the peak on capital values so making sure one gets a decent yield is important as we've had capital gains for a while and the market could be ready for a pause.

Most of this will be pointed out to you by a decent lawyer as Devo says.

Thanks for the insight! Really appreciate both you and Davo advise. Looks like commercial properties are more complex than I thought. Will not rush into it. Will consult lawyer, accountant and seasoned investors like you before making my first commercial purchase. Thanks heaps!

[Rosco]

A lot depends on your aims and goals with the property. But I see 5% as way to low. What is the point?

Unless,
- you can add value
- the rent is way below market and you can move up considerably over time
- you are debt free, but even then I would try to buy better.

Say you buy a commercial property for $1million with 5% return. You borrow say $500,000.
Rent $50,000
Interest might be $25,000
Accounting might be $1500
Principal might be over 15 years, so in really simple terms $23k per year

Overall cashflow = 500. So you have invested $500,000 to return $500.

Ross

[chrisgoh]

A lot depends on your aims and goals with the property. But I see 5% as way to low. What is the point?

Unless,
- you can add value
- the rent is way below market and you can move up considerably over time
- you are debt free, but even then I would try to buy better.

Say you buy a commercial property for $1million with 5% return. You borrow say $500,000.
Rent $50,000
Interest might be $25,000
Accounting might be $1500
Principal might be over 15 years, so in really simple terms $23k per year

Overall cashflow = 500. So you have invested $500,000 to return $500.

Ross

Gosh! the numbers look pathetic!

It will be a debt free purchase and I am planning for gradual rent increase to improve the yield. You are right, not a smart buy. Need to relook at the numbers and continue to hunt for better deals. Thanks for the heads up Ross!

[Anthonyacat]

Ross' figures are a little pessimistic, in that the $500 cashflow is only until the first rent review (then again, interest rates could rise, too...) and after 15 years you are no longer paying a mortgage so no principal or interest, cashflow suddenly increases up to near $50k - plus any rent increases.

[Davo36]

A lot depends on your aims and goals with the property. But I see 5% as way to low. What is the point?

Unless,
- you can add value
- the rent is way below market and you can move up considerably over time
- you are debt free, but even then I would try to buy better.

Say you buy a commercial property for $1million with 5% return. You borrow say $500,000.
Rent $50,000
Interest might be $25,000
Accounting might be $1500
Principal might be over 15 years, so in really simple terms $23k per year

Overall cashflow = 500. So you have invested $500,000 to return $500.

Ross

You surely have to count the principal amount you're paying? After all you are getting richer by that amount each month.

Also, if you have more than one property, then surely the accounting doesn't really go up much with one more?

But yes I agree, yields are too low to be worth it just now, unless you can change things around like others say.

[Nick G]

A lot depends on your aims and goals with the property. But I see 5% as way to low. What is the point?

Unless,
- you can add value
- the rent is way below market and you can move up considerably over time
- you are debt free, but even then I would try to buy better.

Say you buy a commercial property for $1million with 5% return. You borrow say $500,000.
Rent $50,000
Interest might be $25,000
Accounting might be $1500
Principal might be over 15 years, so in really simple terms $23k per year

Overall cashflow = 500. So you have invested $500,000 to return $500.

Ross

Actually you've invested $500,000 to return $23,500, on which you pay income tax.
In year two, all things being equal you pay $23,850 in interest etc.

[Anthonyacat]

Actually you've invested $500,000 to return $23,500, on which you pay income tax.
In year two, all things being equal you pay $23,850 in interest etc.

I'm sure Ross knows that - but he's talking cash returns. So interestingly, in truth you're probably not just only getting $500 per year, but actually cashflow negative (and increasingly so year-on-year, if no rent increases) until the mortgage is paid.

In accounting terms you're earning profit, but in terms of the cash in the bank, what you can actually see, you get nothing.

[Scouser]

"The owner did not have IEP report. The BC management are not planning to get the report until it is pass into law. The building was built around 1980s, seems to be in good condition"

The act around earthquake prone buildings needing to have minimum 34% NBS was passed ages ago. It is law. How this is implemented varies by council or territorial authority in their terms. There was also an amendment act, which I thought came in to force in July whose main purpose is to be more specific on how the process is enforced I think but haven't gotten around to researching it properly.

Let's be clear - there needs to be an IEP unless the building is relatively new. I don't know whether 1980s is new enough to be up to scratch. You will be forced to bring the building at your cost up to standard at some point if it's not. This is a potential significant liability. You can ring the council about this and get their view as there can be exceptions. For a property I purchased in Hamilton the council told me it was new enough to match their earthquake standards, had been consented by them and they were happy with it.

FYI in Auckland this is not a real risk rather a legislative risk IMO. NBS is aimed at earthquake prone areas and the government took a broad brush approach and did not vary by the seismological stability of different areas as they got caught by surprise with Christchurch. Auckland is seen as very low seismic risk by NZ standards. However, it cannot be ignored despite this. Banks don't like to loan if below minimum NBS, buyers don't like to buy and at some point if below the minimum you will be forced to bring it up to standard.

[Davo36]

Well, I'm pretty sure an IEP is not a requirement, not in Auckland anyway.

And if built in 1980 then should be fine. It's pre 1976 you have to worry about.

Yes it's a legislative thing, not really a safety thing.

Mine is at 53% in Auckland, never had any hassles with insurance or lending against it.

[Scouser]

Well, I'm pretty sure an IEP is not a requirement, not in Auckland anyway.

And if built in 1980 then should be fine. It's pre 1976 you have to worry about.

Yes it's a legislative thing, not really a safety thing.

Mine is at 53% in Auckland, never had any hassles with insurance or lending against it.

Sorry I phrased that rather badly - I did not mean it's a regulatory requirement to have an IEP - that varies by council - I meant if there is doubt around NBS value you must have an IEP prior to deciding.

Ditto for me on the NBS affecting lending or insurance and I'm down to 34% though in Hamilton. I've heard anecdotally of issues with minimum NBS in earthquake prone areas such as Wellington. Be interested to know of any real feedback.

[chrisgoh]

Ross' figures are a little pessimistic, in that the $500 cashflow is only until the first rent review (then again, interest rates could rise, too...) and after 15 years you are no longer paying a mortgage so no principal or interest, cashflow suddenly increases up to near $50k - plus any rent increases.

Looking at how the interest rate will probably move in future, it seems the yield is not worth the risk. As what Ross said, there are better deal out there for debt free purchase.