Hi to all,
I have a question when it comes to comparison between purchasing commercial vs residnetial property such as houses, units, townhouses etc.
Which of the two would be the best to invest in when you look at Capital Appreciation, Yield, General expenses and potential difficulties being borrowing from the bank, getting tenants etc.
Please discuss as i'm interested in one commercial property which is selling for $585,000 has a tenant in place which signed 2 year lease and will extend the lease for another 3 years and who leases the space for $4,000 a month.
Space is around 80m2 and is in good location in alexandria in sydney. The commercial building is only 3 years old.
thanks
michael
Hello Michael
I am no expert in this area but since no one has answered you I will tell you the little I know.
I have 1 commercial property and the return is better than residential. It also has the advantage that normally (check the lease) the tenant pays all outgoings (rates,water,insurance,maybe some repairs, land tax at single holding rate naturally) and may even be required to paint your property every so many years. Again, all agreed on via the lease. I am talking about industrial commercial property which is what mine is, but I believe that the rules are different for offices or retail commercial property. Any commercial REA will be able to give you this information.
The thing to remember about the CG on a commercial property is that it's sometimes positive and sometimes negative. The value of a CIP is based on it's return and in bad economic conditions, when rents usually drop, so does the value of the property. However this rectifies itself when the economy improves.
Getting a tenant is also quite a different story than for residential property. Generally it takes much longer, again depending on the location and the economic conditions. On the plus side once you have a tenant they usually stay a long time and most leases have in built yearly rent adjustments. Mine has, thank goodness, just asked to renew the lease for a further 3 years. They have been there 6 years now and unless they go broke or outgrow the premises, should stay for many years to come hopefully. However, it took me 9 months to get them when my old tenant left. Something to consider when calculating how much reserve you need to hold.
What sort of CIP is it that you are looking at?. You say they have a lease for 2 years and will extend the lease for another 3 years. Maybe you mean they have an option for 3 more years? If so then they are not committed to extend the lease. You are committed to give them an extension (subject to any rent review agreements in the lease) but they are not committed so don't take that to the bank yet.
Hope this is a start
ElkaHere are links to 2 sites for more information. The first is a thread on Somersoft to discuss CIP's
http://www.somersoft.com/forums/showthread.php?t=29333
This second one is to a site which also sells commercial property as well as acts as buyers agents but has some good information there. Also if you join (free) they will send you some more educational reading.
Hi Elka,
Thank you for your help! It definately makes it easier once you know someone that has a commercial property and has gone through the difficult and good times as you have.
We are looking at a commercial property that is in a good location, fairly new, has long lease and decent return.
We have found such a place but we need to look at the lease contract to determine if the existing tenants are going to extend their exisitng lease for another 3 year period.
Currently their two year lease is expiring soon so i might need to get an assurance that the current tenants will extend their lease.
What other things should i look out for before i purchase the commercial property when it comes to the lease agreement?
Thank you once more for all the help and the links.
Michael
Hello Michael
As I said I am no expert and only have a bit of experience with an industrial CIP.
You didn't say what sort of commercial property it is. I believe different types of commercial properties have different lease conditions normally. What I would do before I bought anything is take the lease to my solicitor who is experienced in this area and ask him to give me his comments on the lease. What is good, what is bad and what is missing.
However you are buying the premises and not the tenant so you need to research how easily the property will rent if the tenant leaves and if the current rent is fair market price. What to look for is obviously different if it is a shop as opposed to an industrial property.
I am a little puzzled though. You say the property is new (3 years old…good depreciation deductions) yet you also say that it's got a long term tenant. The way I read it, by what you have said, is that this tenant is the first after the IP was built and took, for commercial understanding, a fairly short term lease (2 years) with a 3 year option.
How much longer before the lease expires? With a lease option it's normal that the tenant needs to declare, on paper, their intention to extend or vacate several months before the termination. This is to give you time to re-market the property if he is leaving.This time period should be stated in the lease and what usually happens is that the agent writes the tenant a letter X months before the lease expires and asks them their intentions. Check if this has happened and if they have received a reply yet.
You might like to get a book entitled "How investing in commercial property really works" by Martin Roth and Chris Lang. ISBN 0 – 7314-0293-6. I found it a good read.
Cheers
Elka
Hi Elka,
The commercial property is retail space which has 2 carparks, garage, and two floors of office space. It is on a good busy road with access to the local shopping centre and it also has security gates on the weekend so there is no possiblity of thieves stealing anything from the premises.
I do believe the tenant moved in straight after the ip property was built. I'm not sure of the details that you have mentioned above as the agent is preparing them at the moment. The things you mentioned will be very helpful to make sure i don't make a big mistake and be left without a tenants few months down the track if i do purchase the commerical premises.
Thank you for all the great tips and i will look today for the book you mentioned above.
I will give you more info once i receive all the details.
Cheers,
Michael
One thing not answered so far for you was to do with Capital Appreciation. The scarce thing in Real Estate is Land. Realistically, the only thing that makes Real Estate go up in value is the scarcity of the land underneath the building.
So in terms of Residential vs Commercial, the major determinant of capital appreciation is (a) how desirable the piece of land underneath the building and (b) what percentage of that land do you own? Without fail, owning the entire piece of land as opposed to a unit in a strata titled property will provide better capital appreciation over the long term (all other things, such as location, being equal).
So when weighing up the long term potential, ask yourself how much land are you buying? High rise apartments tend to do worse in terms of captial appreciation because they represent 1 piece of land divided by 100 or so units. A single-family-residence or a commercial building on it's own piece of land is a 1/1 investment in the land. Buildings depreciate, wear out and go down in value, land appreciates in value.
Note I am only talking about the capital appreciation aspect of the investment here, not the suitability of the investment as a whole.
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