30 Jul Is Commercial Property A Good Investment? Thor Harrison Take Us Through the Pros and Cons
In this week’s episode of the Rentvesting Podcast, we’re talking about commercial property. This week we’ve got a special guest, Thor Harrison who is a commercial real estate agent and manager at Net Rent Property in Brisbane. So far on the Rentvesting Podcast, we’ve only spoken about commercial properties in the sense of REIT’s and investing, but today we’re going to talk about:
- Why commercial property?
- Types of commercial property
- Risk & Return of commercial
- Tennant risk
Background on Thor Harrison:
Net Rent is a commercial real estate agency. Thor started in property development and 10 years later he now does sales, leasing and property management.
That’s commercial property, to retail, to industry warehouses. In terms of property management, it’s more industrial, with a number of tenants in retail and the rest is commercial office.
What is commercial property?
Commercial property is more of a return based investment, so people are looking at it based on yields and some sort of financial security with a long-term tenant. You have a lot of self managed supers, mums and dads looking to park their money and longer lease terms.
Main types of commercial property
- Retail – i.e. Nandos
- Industrial – i.e. supply Woolworths groceries, distribution.
Advantage and disadvantages of commercial property?
The advantage of investing in commercial over residential is the return.
Residential is lower risk with 4 – 5% return but commercial you’ll get 10% on a good day.
What are the risks involved with commercial property?
The biggest risk would be the vacancy time; it’s never easy to find a tenant. Commercial you could be waiting for up to 12 months before you find someone. The risk is also that the tenant doesn’t always survive. In retail particularly – the mum and dad style businesses can really struggle. It’s all about finding a good solid tenant and making sure there are guarantees in place so if they go early, you can chase them. Even just a bond to cover you for three months of finding a tenant is important to have in place.
In some cases, the landlords often manage properties and the tenant hasn’t looked through the lease properly. With commercial, what are the things people need to think about before getting a tenant?
Worst-case scenario? There are a lot of people who just really want a tenant and they wont do their checks. It’s a good idea to get history from a past landlord or someone they have a line of credit with. Also check their profit and loss, assets and liabilities to be sure.
Yield and leases
Compared to residential – commercial does cost more, because you’re getting a higher yield, but the finance you’re putting down is about 30 – 40%. Getting into it, the yield is a big thing, so there are net and gross leases.
Net lease is where you’ve got a tenant paying all your costs, often not including the land tax but some leases have all costs, so you have no expenses. That’s rates, electricity, water, internet, so what rent they pay goes straight into your pocket.
For a gross lease, the rent is higher to account for it. It may be set by per square metre at $400 per sqm net plus outgoings, another $100. It depends on who negotiates the deal and the owner’s profile, how they structure the business.
Most importantly, look at net return and ensure you are covering bank costs.
Keeping on costs, if you’ve got tenant paying outgoings it sounds pretty good until they disappear, so there’s that risk there.
What about maintenance cost, who looks after that?
This is good for a commercial owner, as it will be a tenant cost and it’s budgeted for. So depending on the lease there should be an outgoings budget which the tenant pays monthly. The only thing you can’t capture is capital costs. For example, fixing a whole roof can’t be passed on to the tenant but repairs and maintenance is fine.
So with lease terms, residential will be 6 – 12 months then you’ve got to find someone new or extend.
There are different assets with commercial, but in general what are the lease terms?
It’s usually 3 -5 years initial term, then there can be optional for additional years. If the tenant hasn’t done the wrong thing, they have a right that they can stay with the lease – you have to give it to them.
Also on that, what are some incentives with commercial?
Well, in some of the tough areas they throw in incentives.
How does that affect yield?
There are normally two approaches, tenants will ask for a rent discount or rent free as the incentive. Normally it’s one or the other, but sometimes both. Traditionally it’s been one month free for every year of lease. They’re the incentives you’ve got to take into account.
If you’ve got a blank retail space and they fit out a Nandos, when the tenant leaves, they’ve got to change it back to be a blank space again. However, if you see it as an advantage and you want to add to it, you can. So you can offset that for not having to give a bigger incentive.
Finance in commercial
Lopping back to the finance side, so with residential you can get away with a 5 – 10% deposit, while in commercial its generally 25 – 35% deposit , sometimes higher.
So is it as accessible as buying a unit or home? No, it makes it really tough. But if you’re looking at diversifying your portfolio it could be good.
So I guess, just rounding it off, there are three types of commercial investments:
The advantages are that they’re great because you get a higher return, but there’s more risk around tenant vacancy, incentives. You’ve also got concerns like buying in an area that has no growth. If you’re looking for growth over return, then look at residential. Another advantage is the duration of lease, with the tenant in for years and years. The downside is that it has a higher cost of entry and the tenant risk. However maintenance cost is covered by the tenant as with outgoings, so you don’t really need to worry about it.
If you’re comparing it to shares, there’s a higher barrier to entry with costs and liquidity if you want to get in at a lower cost there’s always funds you can access, where people are managing the asset and they’ve done the investigation with regards to returns. That’s on the real estate investment trust and is worth looking at if you want exposure but you don’t’ have the deposit, it could be how you get into the market while you’re still building it up.
Three takeaway points:
- Long dated lease terms can be powerful.
- Return is higher than residential – but there are risks.
- More capital – when you’re financing you need a 30% deposit on these types of commercial asset, so keep that in mind. If you’re looking at a return based on your equity it could be lower than residential where you only need 5 or 10% deposit.
Want to know more about Thor Harrison?
Website: ThorHarrison.com.au or visit the NetRent.com.au