Owning a commercial property can be a valuable part of an investment portfolio and can be the natural progression for an investor.
The added benefits of buying a Commercial Property using the funds from a Self Managed Super Fund can also make a huge difference by reducing your tax liability.
Why get a Commercial Property compared to Residential?
Buying a quality, commercial premises with a solid tenant in place who is locked into a sound lease paying a good rent has many advantages over ownership of residential property. Although any lease must comply with the Retail and Commercial Leases Act 1995 it gives the landlord (lessor) far greater scope to negotiate the terms and conditions with a tenant (lessee) compared to the Residential Tenancies Act 1995.
Some of these advantages for a Commercial landlord include;
• The tenant is required to pay your outgoings which could include, Council rates, SA Water rates (including sewer charges), Emergency Service Levy, Building insurance (including plate glass cover), Strata fees (including some or all of the maintenance levy), Common grounds maintenance, After hours lighting and After hours security costs. (you are not permitted to charge the tenant land tax).
• Tenancies have lease options for a minimum of 5 years compared to the usual 1 year for residential.
• Tenants are required to be responsible for much more of the maintenance of the property such as servicing of air conditioners and fire safety equipment and replacement of things like lighting and floor coverings as they use and wear them out. They may even be required to regularly repaint and even refit a shop/display rooms plus do basic repairs like fixing leaking taps and unblocking drains. Some of these things will depend upon the quality of the lease in place. Shopping centre leases tend to have many more requirements for periodic refitting of the premises.
• You have a much greater ability to negotiate the terms of a lease compared to residential leases which are strictly limited by the Residential Tenancies Act 1995.
• The requirements upon a tenant to make good a property at the end of a lease can be quite stringent. They may be required to repaint and recarpet and to otherwise fully reinstate the property to the way it was before the lease started.
• Your Commercial Real Estate Agent could negotiate a lease which requires the tenant to pay all of their monthly management fees and annual reconciliation fees for Outgoings. (this will not include lease renewal costs or rent review fees).
• The tenant is usually required to pay half the cost of the preparation of a formal lease.
• The tenant can be asked to secure a bank guarantee for equivalent to a reasonable amount of, say, 4 month’s rent. This guarantee will be held by the lessor and can be claimed directly from the bank if the tenant were to break a condition of the lease, such as not paying rent or outgoings. This is independent of and can be additional to a bond.
So the returns for a commercial landlord can be very attractive but going in this direction is not something that should be embarked upon lightly or as a curiosity.
But we would never recommend making your first purchase a commercial property. Think of it a little like in the game of ‘Monopoly’ where you own 4 houses then trade them in for 1 hotel. In the same way you should build up a good portfolio of houses first before dabbling in commercial or industrial properties. But rather than selling off all the houses to buy the 1 commercial property endeavour to retain the houses as a buffer.
Even though you may acquire a quality commercial premises with that solid tenant paying a good rent with a sound lease you still need to have other assets to fall back on if things go pear shaped. When things go wrong in a residential investment usually that property could quickly be put on the market and sold but it is not always so straightforward with commercial properties.
If your solid tenant were to suffer a financial disaster and your cash flow were to suddently cease you can’t rely upon selling your commercial property to bail yourself out. You need to have at your disposal some residential properties that can be quickly sold or some other asset that could be quickly cashed out.
What makes one Commercial Property better than another?
The factors influencing the value of your commercial or industrial property will be completely different to those influencing the sale of a residential property. The state of the commercial market can be completely different to the residential market even in the same suburb.
It is therefore important to select the services of a real estate agent who knows commercial sales and leasing.
Factors that affect the value of a commercial property:
• Type of Premises
• Lease or Ownership
Type of premises
These are the things that broadly speaking the owner or occupant can control to one degree or another.
General description of the site
For example; Office, Retail shop, Showroom, Warehouse, Workshop, Manufacturing etc.
Broad details of the premises
The single most important factor is the area of the buildings in square metres followed by the overall site area, staff amenities and details of car parking facilities and outside storage and/or outside work areas.
Specific details of the buildings and facilities
Roof clearance, type & standard of construction, clearance of access points such as roller doors or personal access doors, windows, ventilation, fire protection apparatus, electrical facilities eg. 3 phase power plus security systems and elevators.
Questions will get very detailed regarding the type & standard of road surface in car park & other areas or is there enough space for a semi-trailer to be able to do a U-turn. What about the presence of cleaning bays set up to Environmental Protection Authority standards, and so on.
These are most often the things that can’t be controlled by an owner directly.
The suburb could be quite ok for the type of premises in question but is it in the best part of that suburb like an industrial park in that suburb or the well known retail precinct that serves the business best. The suburb might be good but for a business that needs traffic flow but that business would struggle if located off a back road.
A manufacturer may not need to be on a main road but it might need semi-trailers to be able to pull into the allotment and this is best done from a quieter side street. However it can be a big advantage for this side street to be close to a main road.
A retail shop or furniture showroom would need a prominent location on a main road with lots of passing traffic.
Lease or Ownership
The lease or type of ownership is the biggest single factor that determines the value of a property and this will be determined by the professional services of an experienced Commercial Real Estate Agent.
Once your Commercial Real Estate Agent has found a Lessee (tenant) the task of leasing a commercial property has only just started. From the first point of contact your Agent must continue negotiations to secure a lease for the very best terms for the Lessor (Landlord).
Many of the conditions acceptable to the Lessor would have been promoted on all marketing from the beginning of the advertising campaign but it is up to your Agent from this point to continue negotiations to bring these terms and conditions to fulfilment in the Lease.
The Agent should employ experienced Commercial Lawyers to construct a ‘water tight’ lease in accordance with current legislation.
Without the right lease put in place the value of your Commercial property may be a fraction of what it could be when sold.
The conditions of the lease that bind the tenant (lessee) will determine the return (income) generated and the higher the return the better the investment and therefore the greater the value of the property.
These conditions start with the most obvious and progress to those more subtle requirements the tenant must adhere to;
• Annual rent
• Payment of outgoings
• Length of the lease
• Rent increases/reviews
• Rights of renewal
• Requirements to upkeep the property
• Conditions for making good the property upon vacating
• Sanctions if the conditions of the lease are not followed
Alternatively if the owner occupies the property on a casual basis and wants to sell up and move out then the value of the business to the property becomes irrelevant. Any Commercial Sale will only be determined upon the value of a vacant building.
But if the owner/occupier wishes to sell and rent back from the new owner his business can potentially be of value as part of the sale but only if they enter into a binding lease with favourable conditions for the new owner that will guarantee them a good rent for a long period.
The difference between a Commercial and Industrial Property
Industrial and commercial properties are treated quite differently according to the Retail and Commercial Leases Act 1995.
Broadly speaking any premises where the public have access to buy goods by retail or where they receive services or where they negotiate for the supply of services is governed by the act. This can include any retail shop or office. But where the public have no access as in a manufacturing plant then the act does not apply. This means the Landlord (lessor) has the greatest ability to negotiate the terms and conditions of a lease. Where the Act does not apply the lessee can be charged for Land Tax but a whole new range of options start to open up. The structure of a lease will then only be governed by the prevailing laws of the land and what the lessee is prepared to pay or do to secure a property.
The Act will not apply in a number of situations including the following;
• A business premises where the annual rent is $400,000 plus GST
• A lease of one month or less
• An agreement for the sale and purchase of premises
• A mortgage
• Some select lessors ( a number of government affiliated organisations )
• The lessee is a government agency
• The lessee is a municipal or district council
• The lessee is a public company or its subsidiary
• The lessee is a body corporate authorised by law to carry on the business of insurance.
For more details see the Retail and Commercial Leases Regulations 2010
How Commercial rents are described.
Rents are usually described as a cost per square meter of the rentable area exclusive of GST. The rentable area would not include carparking or general open space but would only refer to the usable space under roof.
Methods of calculating the rentable area can be complicated including the BOMA (Building Owners and Managers Association) standard method for measuring floor area in office building. But for many smaller simple structures it can equal the internal measurement of an office or retail space.
So if the area of a retail shop was 70 sqm @ $140.00 per sqm = $9,800.00 per year. This is called the Base Rent.
Most usually the Base Rent would be advertised as $9,800.00 plus GST and Outgoings.
The other most common method of charging rent is as a Gross Rent. This means the rental figure includes outgoings. Although this makes it much simpler an owner will find that as outgoings increase the amount of rent they get for the property gradually reduces.
It also becomes much harder to calculate any rent increase because outgoings have to be removed first to find the base rent is then add on the true value of outgoings to an updated base rent then add them together again to find a new Gross Rent.
Rarely would a professional Commercial Manager opt for a Gross Rent except for the lowest rent commercial sheds where it suits the tenant.
Buying or Selling a Commercial Property
If you are looking to buy or sell a Commercial property for a fair market value then the first factor will be whether it is vacant for leased.
If it is vacant you will only be considering the following variables;
• Land value
• Land value plus improvements
• Planning laws or other proposals of government or council that may be factors.
Many sites have been tailor made for a tenant so the land value and land value plus improvements could be very similar. The old wool sheds at the Port Adelaide wharfs have been vacant for so many years it would be considered the improvements are a liability and actually reduce the value of the land because any future developer would have to pay to have them demolished.
Any regulations that might soon come into force that could change zoning or prohibit certain industries or business could either have a negative or positive effect.
Where there is a tenant in place it becomes a new ball game as a 4th value comes into play.
The value of a leased property will be governed by the quality of the lease in place. This will tell you what the annual net rent is and will help to determine what the rate of return is for the owner of the property.
The rate of return is expressed as a percentage figure. A high percentage shows a high risk and a low percentage shows the property is a low risk investment.
The high risk might mean the tenant pays a comparatively low rent for an office with a periodic lease that only offers annual rent increases at the CPI. This rate might be, say 9%.
A low risk might be for a long term Government Department in an office on a lease with 3 renewal options of 5 years each. It might offer annual rent increases of CPI plus 2% with a review to market at each renewal. This rate might be, say 5%.
At first appearance it looks like the percentage figures are reversed but it must be remembered that this percentage equals the proportion that the annual base rent bares to the total value of the asset.
To calculate the value of the asset use the following formulae:
Annual rent = Total value
Rate of return
In this example, if the rent paid by each tenant was the same at $50,000.
For the high risk investment with poor lease;
$50,000 = $555,555.00 for the value of the Property
And for the low risk investment with quality lease;
$50,000 = $1,000,000.00
So you will see that by having a quality lease in place has almost doubled the value of the property. This shows graphically the merit of having a good Commercial Agent to set up the lease.
To see some more detailed information on the sort of things you should look out for when buying a property see the page; IDEAL COMMERCIAL PROPERTY
If you are serious about investing in Commercial property or in getting the maximum in any Commercial Sale then you need to speak to experienced Commercial Agents.
Give us a ring or contact us using the section below;