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The Pros & Cons Of Commercial Property Investing

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Transcript

The pros and cons of commercial property investing. Now, there are many pros and cons that come with commercial property when you’re looking to compare it to residential, but let’s go into three of each side for now just to give us a bit of a taste and just so you can understand what some of the main key good items are and then some of the items where there is some opportunity to understand the risk that comes with it.

Now, if we’re looking at the pros, pro number one is higher income. You may have seen some of the yields that commercial property can present. Now, firstly, what’s really exciting is that these aren’t gross yields in most cases, they’re net yields. So, after all the outgoings, you’re left with money to pay the mortgage, and, most likely, some extra left over when you’re investing in commercial property. These yields have gone from five, six, seven, eight, I’ve even some double digit yields that are net on your return when purchasing the asset.

Some other pros, or the two others that I’d like to talk to as well are longer leases. Now, when you’re looking at a lease of residential property, usually, they’re six to 12 months and sometimes periodic on the month to month. There have been rare occasions in some areas where you can get a two year or a three year residential, but that’s very, very, very rare. Now, with commercial property, A, you can get two years, three years, five years and sometimes even 10 year leases, and you can also get something called options. Basically where you’re offering the tenant an opportunity to renew their lease for another five years or another three years on similar terms as the first set of years that you gave them.

Here’s an example. A three by three, by three. What that basically means is a three year option, on top of another three year option, on top of another three year lease. At the end of each term, the tenant and the landlord have that opportunity, usually three to six months before the lease ends, to discuss whether they’re taking the option up or not.

Now, the third pro that comes with it is power to the landlord. If you’re wondering what power to the landlord means, is you would have perhaps seen some recent changes in the residential tenancy acts over the last few months and few years, basically trying to find that balance in the rules for tenants and landlords. Now, in the commercial property front, usually the power comes in more favor to the landlord. Here’s some examples. Annual increases built in the leases. Another example could be where if the tenant has done some fit outs on the property, they can actually, at the end of the lease, ask the tenant to bring all the things on the property back to the original state.

Another pro of the power to the landlord is when tenants can actually do fit outs, but the landlord’s receiving the benefit and they’re keeping the fit outs at the end, should they want to leave it there even beyond the lease. Now, that’s adding value and more power to the landlord in terms of what they can do. The last part of power to the landlord is where you can have security deposits, sometimes they call them bank guarantees. In the residential front, when you’re looking at investing in residential property, these are usually four weeks of your rent, sometimes referred to as a bond. In commercial property, this can be three months, six months, and sometimes even a personal guarantee gets the director’s name in case they default on the lease, and that will take you to cover you all the way to the end of the lease. Something that can also occur.

So those are the pros, let’s talk through some of the cons. Now, before I go into the cons, it’s important to understand there are many more pros that exist in commercial property, but for the purpose of time let’s go into the cons now. Three cons, higher or longer vacant periods. Now, you’d imagine, okay, everyone or most people would live in a house or a unit or some sort of other residential dwelling, but not all people will want to live in that business asset or the commercial property that you’ve purchased, because if you’ve purchased a warehouse, why would someone who sells clothes maybe want to use that warehouse when they could maybe look at a retail front? Or why would a industrial company want to operate from a medical suite? You see, it’s about business fit to commercial property, and that’s where you can sometimes have longer vacant periods, because there aren’t as many businesses operating as there people who want to live in houses or units and so forth, which is why vacant periods can be a little bit longer when it comes to commercial property.

Another part is actually the industry disruption. Let’s talk offices, for example. Offices are going through a change where people are working from home, working flexibly, and there are even some places that do co-working or shared office spaces, and you can imagine all those people who are paying hefty rents for massive office spaces that may not need it anymore because of the changing environments, or the disruption from these other companies. Suddenly, that office doesn’t produce as much results for, perhaps, the rent or perhaps the vacant periods. So this is just one example, although there are still many office locations that are performing extremely well. That’s just one example of how disruption in the world can actually start to impact the commercial property or the type of property you’ve purchased.

Now, lastly, an important one is to consider leverage. If you’re looking at commercial property versus residential property, in residential property, sometimes you can get 90% loans, even 95 and beyond. In commercial property, the standards are usually 70 to 80, although there are exceptions where you can get a little bit higher. Now, if you’re thinking of specialized commercial, these even go lower then 70. We have started to get 55, 60 or 65% lending maximum amounts. What that translates to is you need more of a deposit to put down.

So those are examples of three pros and three cons of investing in commercial property, and something for you to consider when you’re considering commercial as part of your investment strategy plan. That’s it from us here at InvestorKit, the experts in wealth creation helping you take action.